[Aditya Bhayal is a IV year student at NALSAR University of Law, Hyderabad]
In this year’s Budget Presentation, the Finance Minister announced the introduction of the Social Stock Exchange (SSE) in the Indian capital market. Following this, the Securities and Exchange Board of India (SEBI) recently set up a panel to provide recommendations on the working and implementation of this concept. In light of this unprecedented move, it is essential to examine the challenges that it is likely to face.
Impact investing is a unique form of investment which seeks to do social good by channelizing the market forces in a direction that addresses the pressing social issues. In order to achieve this goal, however, impact investors bear the task of striking a fine balance between two somewhat opposing imperatives, i.e., financial returns and social benefits. Impact investing lies at the crossroads between philanthropy and commerce and is a sort of hybrid which has an added objective of public welfare to go along with the conventional motive of attaining profits. SSE is a measure that will facilitate the investors’ objectives of achieving wide social impact through their investment. This exchange intends to list various social enterprises and voluntary organizations to enable them to mark their presence on a platform to raise the finances needed to sustain their working.
Functions of the Social Stock Exchange
In the absence of a SSE, the market lacks regulatory tools that can meticulously separate the social impact investors from their respective counterparts present in the stock exchange. These differences need to be drawn in an effective manner, failing which the social finance will not be able to achieve its stated objectives. This regulatory vacuum needs to be filled with significant rulemaking. One of the central functions of the SSE would be to assist these enterprises to commercialize their financing to enable them to raise their operations and reduce their dependency on grant funding. Secondly, the SSEs undertake the work of creating a separate marketplace for social finance, thereby differentiating them from the conventional financial market where the major aim of the investor is to obtain maximum return on their investment. The SSE can accomplish this by formulating listing criteria for the entities interested in listing on their platform; formulating rules to govern such transactions; laying down requirements to be complied with to stay listed; and establishing guidelines on the basis of which the investors would be permitted to ply their trade on the platform. Further, the SSE can lay down the mechanism for enforceability of its rules and the conditions for delisting. All such rulemaking processes will go a long way in concretising the difference between the conventional stock exchange and the SSE.
While the SSE would develop regulations that would govern the social dimensions of impact investing, the exchange itself and the entities listing with the exchange would have to remain compliant with the corporate laws and the rules laid down by SEBI. This would be essential as SEBI, as the regulatory authority over the capital markets, would seek to lay down certain additional criteria for the protection of investors. Listing requirements, disclosure requirements and corporate governance are some of the devices through which the conventional stock exchange regulates the financial market. The SSE can use some of these measures to regulate the impact investing sector. But a major challenge for the SSE would be to tailor the devices used by the conventional exchange in such a way that it effectively mitigates the risks brought about by social investing and addresses the new found challenges associated with it.
Key Takeaways from other Jurisdictions
Socially Inclined Decision Makers
While the conventional stock exchanges demand entities listed with them to make disclosures and comply with corporate governance norms to verify their financial integrity, the SSEs on the other hand will collect information to check the issuer’s social integrity. One way to ensure that the social mission of enterprises is not compromised is to mandate these enterprises to have personnel with proven social inclination on the decision making bodies. One viable option can be to appoint a social director whose role will be to monitor the activities of social enterprises and ensure that they stay true to their commitment. This is crucial to protect the interest of the investors, as these investors invest the capital with a social objective in mind and, if that capital is used to further the commercial purposes of the enterprise, then the whole objective of investing is defeated. Such a step has been taken by the Impact Exchange (IX) of Singapore and Mauritius where they have mandated the potential issuers appoint an Authorized Impact Representative (AIR) to ensure compliance. Having such representatives on board would increase the confidence of the investors as these representatives can ensure appropriate usage of the capital.
Regulating the Investors
In a SSE, it will be essential to regulate the conduct of investors as their activities might sacrifice the whole mission of the entity. The regulator will need to tackle the situation of short-termism as many investors compromise on long term opportunities to derive some short term returns. This phenomenon of short-termism is dangerous for the impact investing sector where the social impact can take years to materialize. It might be that the financial returns are not satisfactory for indefinite periods of time. If the investors exit too early, they could jeopardize the whole social aim of the issuers. Further, the investors might also pressurise companies to prioritize financial returns over the social impact, which could defeat the whole purpose of impact investing. Due to such reasons, there needs to be a proper screening of the investors who can be permitted to trade on the exchange. The process adopted by the SVX in Canada can be a good example to consider. There is an SVX investor agreement which states that the investor acknowledges the fact that its investment might not bear any financial returns. The Canadian practice effectively weeds out those investors who prioritize profit over any social gain. This agreement can also be used by the investors to decide if such investments really suit their needs.
Another policy that can be adopted is an Investors Code of Conduct. SSEs can ask the investors to subscribe to the code mandatorily before investing. This code can lay down some “dos and dont’s” for the investors, which seek to build their commitment towards the mission. It can explain what it takes to be a patient impact investor. It can also lay down a minimum holding period for the investors while also asking the investors to sell their securities only to those investors who have subscribed to the code. These measures would enable the SSE to ensure that investments are routed in the right direction and the necessary impact is also created.
Impact Assessment and Reporting Requirement
Just like the businesses currently listed on exchanges carry out financial reporting, the social enterprises listed on the SSE will have to embark on social reporting in the same way. Monitoring the reporting by social enterprises is challenging as there are no defined metrics or standards for capturing social reporting. It is difficult to ascertain the actual social impact brought about by the entity. This can lead to investor taking decisions based on incomplete information. This can also lead to a scenario where the investors shy away from investing in enterprises which actually have the impact but are failing in the quantitative assessment. If the SSE does not specify a concrete reporting standard, there are chances that the businesses might opportunistically select those standards which are easiest to satisfy. Then the burden will shift on the investors to unearth information about the enterprises listed on the exchange thereby increasing the cost for the investors. It will be an onerous task for the SEBI to identify well-defined and clear metrics for measurement of social impact. SEBI can engage with third parties like credit rating agencies to rate the performances of the social enterprises in terms of their social impact.
Although such an initiative is a welcome step for the impact investing sector, there is a need for considerable planning before the SSE becomes operational. Whether or not this initiative will achieve its objective can only be ascertained once a proper roadmap with minute details has been laid down by SEBI. The regulator will have to decide on the kind of entities which are allowed to trade on the exchange while also deciding on the set of investors which can invest in these entities. The term “social enterprise” will have to be defined appropriately so that undeserving entities do not misuse the platform thereby endangering the funds of the investors. Further, the matter get complicated as there exist no accepted criteria to measure the returns on investment. In the absence of such criteria, there will be difficulty in assigning value to the instruments to be traded on the exchange. The most important task for SEBI would be to come up with some concrete assessment criteria so that the investors would have some measure to rely on while deciding the credibility of an enterprise. If properly implemented, this platform could provide the much-needed boost to social businesses that have not realized their potential and have not been able to create the intended effect due to lack of funding.
– Aditya Bhayal