Social Stock Exchange: Decoding Regulatory Framework And Its Challenges

While years were spent in other nations to create an ecology for SSE (or its equivalents), all of this transpired within a span of two years in India. This article examines the concept of SSE, its inception, the framework proposed to govern it, how the Indian SSE differs from its international equivalents, and the obstacles that are currently acting as a hindrance to its success.

Concept

SSE has been introduced as a "process" more than a "place" since it will not only allow the securities or other funding structures of SEs to be "listed" (as explained in later paragraphs) but will also be acting as a filter, letting only those entities that are producing quantifiable social impact and reporting such impact to participate. SEs can include both Non-Profit Organizations (NPOs) which include trust, society, or Section 8 Company under the Companies Act, 2013 and For-profit organizations (FPOs) with social intent as their primary goals.

The social stock bourse will serve as a platform to connect SEs and philanthropist investors, where investors will be able to purchase the shares of SEs listed on SSE, whose goals suit their preferences. The value of the securities of these listed SEs shall be determined on the basis of their reported social impact.

Background

Currently, Corporate Social Responsibility (CSR), philanthropy investing, crowdsourcing, etc. are being used to fund India's social sector. However, resources cannot be uniformly accessed by Social Enterprises. SSE, as envisaged by the SEBI Report, was needed to bridge this funding gap for SEs.

Another issue which was needed to be addressed is the challenge of meeting the 2030 deadline for the UN-mandated 17 Sustainable Development Goals (SDGs). In reality, India currently faces an annual funding gap of INR 4.2 Lakh Crore in achieving these SDG targets. This makes it more important for private investors to participate through SSE and carry out the SDGs.

Vision of the SSE, was first outlined by the Finance Minister of India as part of the budget speech for the FY 2019-20, wherein she proposed to initiate steps towards creating a fund-raising platform under the regulatory purview of the SEBI, where SEs and volunteer Organizations might be listed.

Subsequently, the task of evaluating and constructing the framework for SSE was entrusted with the Working group (WG) and the technical group (TG), constituted by SEBI, the recommendations of whom were published in June2020 and May2021, respectively. On the basis of WG Report and TG Report, SEBI in its board meeting dated September28, 2021, approved the formation and framework of SSE.

To give effect to this framework, SEBI, in July 2022, amended the SEBI (Issue of Capital and Disclosure Requirements) Regulation (ICDR), 2018; SEBI (Listing Obligations and Disclosure Requirements) Regulations (LODR); and SEBI (Alternative Investment Funds) Regulations, 2012 (AIF).

Framework for SSE

• Eligibility Criteria: In order to be identified as a Social Enterprise, in terms of Reg. 292E of, ICDR Regulations, NPOs and FPOs, shall, irrespective of their legal structure, demonstrate that social intent and impact are their primary goals and that such intent shall be established through its indulgence in one of the 17 broad social activities, Sustainable Development Goals, or Niti Aayog's prioritized areas (based on ScheduleVII of the Companies Act). The Regulation excludes corporate foundations, professional or trade associations, infrastructure and housing companies (except affordable housing) and political or religious organizations as eligible SEs on SSE.

• Registration requirement: SSE allows NPOs to register on the platform without the requirement of raising funds immediately (direct listing) which in turn will enable them to receive benefits such as, capacity building support in form of social audits and standardized reporting for enhancing credibility and legitimacy.

• Fundraising instruments and Structures:
• For NPOs: In order to enable the fund raising through SSE, SEBI, vide its notification dated July 16, 2022, introduced "Zero Coupon zero principal Instrument" (ZCZP) as a "security" in terms of Securities Contracts (Regulation) Act, 1956, to be issued by NPOs specifically. The step was taken in light of the fact that NPOs, face limitations on their ability to issue other existing securities, viz, equity, debt or units, since NPOs, a priori, have primacy of social impact and are not 'body corporates' as defined under the Companies Act. A ZCZP Instrument, shall not provide any financial returns on the funds of Investor; instead, the return will be in the form of the social impact that the investors seek to create and it shall be tenure specific to the duration of project. In addition to the aforesaid, NPOs can also raise the fund through Mutual Funds by way of receiving donation of returns on investment made by scheme holders.

• For FPOs: FPOs will use the existing fund raising structure, such as equity, debt, Alternative Investment Funds, etc. to raise funds. They will, therefore be required to list on the Main Board, Small-Medium Enterprises Platform or Institutional Growth Platform. In this regard, the listing criteria applicable for for-profit conventional enterprises (FPCEs), who list on the aforesaid platforms, will also apply for FPOs. However, there is a critical difference between the two – FPOs and FPCEs, as the former will have to demonstrate that they are in the business of "creating positive social impact" which will enable them to raise a kind of investment that for-profit conventional enterprises do not have access to.

• Social Impact Funds (SIFs):

To enable the fund raising for SEs through Alternate Investment Funds (AIF), the regulatory body has introduced Social Impact Fund as an AIF which will be investing primarily in securities or units of SEs or Social ventures and will provide returns in the form of social impact to its investors. This, therefore, will facilitate the NPOs to make private issuance of ZCZP to SIF(s) registered in accordance with applicable AIF Regulations.

• Disclosure Requirements:

SEs shall be required to disclose Social Impact Report on annual basis, therefore Audit of social impact shall be mandatory for entities on SSE. The responsibility for conducting the audit of Annual Impact Reports submitted by SEs would be of Social Auditor, registered with a Self-Regulatory Organization (SRO), i.e., Institute of Chartered Accountants of India (ICAI). In this regard, the necessary action at the end of ICAI is under process. Additionally, the entities will be required to annually report general, governance, and financial information. Apart from the annual disclosures, the NPO must notify the exchange within 7 days of any incident that could materially affect the intended achievement of their outputs or results. In case of FPEs, it is important to note that they shall, in addition to the social impact reporting obligation, must also adhere to the applicable segment's disclosure standards, such as main board, SME, IGP, etc.

Social Stock Bourses around the globe and their present status

The Working Group of SEBI had taken into consideration the following countries with an SSE in place in order to analyze its framework in India:

• Brazil: Brazil's Socio-Environmental Investment Exchange - Bolsa de Valores (BVS), launched in 2003, is the world's first SSE. It was launched with the main objective to encourage the involvement of private sector in social and environmental development of the country. The platform enables the crowdfunding for the pre-approved social and environmental projects only.
• UK: The UK Social Stock Exchange (SSX), launched in 2013, doesn't facilitate ample amount of share trading; rather, acts more as an information exchange (reporting standardized and comparable social impact information on its website) with a directory of NPOs and a "social impact test" to become eligible for listing on platform.

• Canada: The Canadian Stock Exchange, Social Venture Connexion (SVX), introduced in 2013, acts as a primary offering platform networking for organizations (with a social purpose) and doesn't allow secondary trading on its platform. Further, it provides returns in the form of social/ environmental and financial returns.
• South Africa: The South African Social Investment Exchange (SASIX), launched in 2006, works like a conventional social stock exchange, wherein ethical investors buy shares in social projects according to two classifications: sector and province. Further it provides Tax benefits to investors and the returns in the form of social and financial returns.

Only Canada is still operating out of the ones stated above; the others have vanished owing to structural and financial problems including a lack of users making it difficult to achieve economies of scale, a lack of knowledge and training, etc.

While the concept of a social stock exchange is relatively new in India as compared to other jurisdictions, its operating mechanism in India is a significant step forward from other models since the approved model of Indian Social Stock bourse is a "donation" based funding platform with the ability to trade "donations" by connecting them with "securities", namely, ZCZP.

Current Challenges and way forward

Despite the fact that the concept of a Social Stock Exchange is promising and may assist SEs in acquiring funding and reaching out to the general public, the question is whether the SEs, particularly the mid and small size NPOs, would be able to meet stringent social audit standards that are still under development and call for greater accountability and transparency in their business practices. In order to be registered/listed on SSE, Social Enterprise(s) would have to reconsider their organizational structure and adopt or modify their standard operating procedures to comply with the stricter reporting and transparency standards, which is a challenging task in itself. A comprehensive comparative study of SSEs worldwide revealed that the social enterprises face challenges with sustainability and scale since project-based funding is more common than organizational support.

Adding further, the other major obstacle for social stock exchange aspirants to overcome is how to measure and standardize social effect measurements within and across industries (such as poverty, health, education, environment, etc). Hence, impact measurement and evaluation remain challenging, and clarity needs to be there in this regard.

Another major issue is that the recent notifications are silent on two prime aspects, inter alia, the treatment of CSR funds in fundraising instruments and the tax treatment of the investments to be made by the prospective investors in the fundraising instruments.

In this regard, the expert working group of SEBI, observed that the Companies' contributions to NPOs on SSE should be counted toward their CSR obligations, in order to provide encouragement to social investors (both retail and institutional) to participate and invest in SIFs. At present, only contributions to Section 8 companies that are registered with the Ministry of Corporate Affairs (MCA) are counted towards Companies' CSR contributions. However, considering the fact that the SSE will facilitate fund-raising and mandate a reporting standard for all its associated NPOs (the ambit of which, is too wide), all NPOs on SSE should qualify to receive funding through CSR, and hence the Amended regulations should have reflected this position.

In addition to this, it was advised to provide tax benefits under Section 80G of the Income Tax Act, 1961, to the investors on all investments made in securities of NPOs listed on SSE, in order to entice investors into the exchange. The recent framework, by remaining silent on these aspects, poses the operational challenges that need to be addressed before the SSE can operate successfully. Hence further conceptual elaboration from the end of Market Regulator, is required on these aspects to make the idea of SSE successful.

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