[Rongeet Poddar is a 5th year student at the West Bengal National University of Juridical Sciences]
The Working Group Report on Social Stock Exchange constituted by the Securities and Exchange Board of India (SEBI) has evaluated the prospect of introducing a ‘Social Stock Exchange’ (SSE). As acknowledged in the Report published on 1 June 2020, the Finance Minister of India had previously called for the introduction of such a trading platform for raising capital as equity, debt or mutual fund units and devoted for social welfare.
The panel opines that the initiation of a systematic regulatory framework would enable investors and donors to contribute to social sector spending in India. It would augment the capacity of private enterprise in response to the unique challenges posed by the Covid-19 pandemic by facilitating the infusion of capital from the private sector in the spheres of education, health and agriculture. The SSE would encourage trading in equities issued by profit-making entities with the help of tax incentives and governance practices such as a common reporting standard. It would include a pay-for-success mechanism that incentivizes increased funding for social enterprises based on performance.
Distinction between For-Profit and Non-Profit
The Report has recognized a distinction between for-profit enterprises (FPEs) and non-profit organizations (NPOs). The distinction between the two categories of social enterprises lies in the capacity of FPEs to raise equity and claim profits. FPEs include companies registered under the Companies Act, sole proprietorships, partnership firms, HUFs and limited liability partnerships. The owners of an FPE are expected to make financial gains. However, an exception has been carved out for section 8 companies. The law prohibits the payment of dividends to the shareholders of these firms. The shares in section 8 companies thus do not have ‘residual claims on profits’. On the other hand, NPOs include section 8 companies, trusts and societies.
The Report has observed that funding in the social sector has been plagued by insufficient funding in the NPOs. It highlights that funding is contingent upon the demonstration of results in the field. However, the absence of a standardized impact assessment has constrained NPOs from showcasing their potential. The philanthropic pursuits under the aegis of FPEs, however, have had greater success, according to the SEBI panel. It has relied on private sector endeavours and the statistics furnished by the Ministry of Statistics and Programme Implementation for its appraisal.
Proposed Architecture of the SSE
The Report recommends the creation of a separate SSE segment under the existing stock exchanges. A set of pre-determined listing criteria would filter entities that are consistently creating a measurable social impact and reporting such impact as well. The FPEs and the NPOs would be subject to a common minimum standard of governance for reporting social impact and operating practices, including financial reporting. The emphasis on transparency in the listing obligations is expected to gradually usher in a viable ecosystem for raising capital in the service of the social sector.
The definition of a social enterprise, according to the Report, would require a minimum reporting standard on the beneficiaries for the immediate term of the SSE. The framework would demonstrate a clear intent on the part of both FPEs and NPOs to create ‘positive social impact’ in the areas of environment, society and governance. It would ascertain the social problem to be addressed and calculate the intensity of social impact on the median individual of the target segment by considering income, social equity and diversity. The social enterprise would also have to furnish relevant information about the members of its governing body, its prior funding history and its financial health in addition to its registrations and licenses.
The Report adopts a ‘self-declaration’ model and deliberately avoids defining a FPE to avoid the pitfalls of a one-size-fits-all approach. The Report puts the onus on SEBI to subsequently work out an assessment mechanism for identifying the self-declared credentials of the FPEs that would certify their social impact capacity. The definition is thus entirely impact-centric. It offers considerable leeway for enterprises to structure their legal form in ways that would satisfy their goals in the best possible manner.
Interestingly, the Report attempts to replicate the monitoring mechanism under SEBI’s Business Responsibility Reporting Framework, which was adopted in 2012 (and presently reflected in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015). The evaluation of social impact would be conducted through the lenses of the beneficiaries. While the instruments listed directly on the SSE will come under the ambit of SEBI’s regulatory jurisdiction, the NPOs will continue to operate outside SEBI’s remit. Therefore, the intervention of other regulatory bodies will also be required to exercise oversight.
The SEBI panel urges the government to evaluate the need for a new regulator at the end of the immediate term of four to seven years that could monitor the entire paradigm of social enterprises, social reporting and social auditors. Finally, it recommends the creation of a database of information providers that would keep track of the activities of the NPOs, including the compliance requirements of the SSE. However, registration with the intermediaries will not be mandatory for NPOs.
The Report has highlighted that section 8 companies have faced hurdles in fund-raising due to their inability to provide financial returns on investments. Since trusts and societies are not bodies corporate under the Companies Act, they cannot issue bonds and debentures, which can be defined as ‘securities’ under the Securities Contracts (Regulation) Act, 1956 (SCRA). However, zero-coupon bonds can be utilized for fund-raising by the NPOs and listed on the SSE.
The operation of the SSE will require SEBI to notify zero-coupon bonds of NPOs as a ‘security’ under the SCRA. The Working Group has proposed that the bonds will have a tenure equal to the duration of funding of the project. The bonds can be written off from the investee’s books after the completion of tenure. Under this framework, investors will be incentivized to channel their financial resources only to NPOs that have a proven record of social impact. Intermediaries will certify the track-record of the NPOs. SEBI and the stock exchanges have been urged to introduce procedural norms for compliance, including the provision of penalties to regulate the funding of NPOs.
The SEBI panel envisions the introduction of a Covid-19 Aid Fund at the SSE with the help of the ‘pay-for-success’ bonds to finance the operations of NPOs that can mitigate immediate concerns such as the migrant worker crisis. Institutional investors or banking institutions are expected to supplement the resources of philanthropic foundations and CSR. The social venture fund under SEBI’s Alternative Investment Fund Regulations has been identified as an attractive route for NPOs to raise funds.
Likewise, the equity-listing framework for FPEs would include financial reporting, social impact assessment and penalties for non-compliance. The Innovators Growth Platform, constituted by SEBI, would serve as a model for finalizing the listing requirements of FPEs as opined by the Report. It would require suitable changes to be made to the thresholds of minimum net worth, average operating profit, prior holding by qualified institutional buyers and the criteria for an accredited investor under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 as necessary.
The funding structures envisaged for the NPOs, such as the social venture fund may also be utilized under the pay-for-success model. It would require SEBI to constitute a mechanism involving social auditors for objectively assessing the self-declared social impact of the FPEs. The Report anticipates the gradual emergence of independent entities that will enable social enterprises to self-report much like the existing audit firms. It is particularly hopeful that the Covid-19 Aid Fund can be bolstered with the help of a ‘structured pooled loan with domestic banks and NBFCs as senior lenders’ and ‘philanthropic contributions, CSR spenders and impact investors as junior lenders’.
Structural Reform of CSR
The Report offers policy recommendations to overcome the regulatory obstacles for the implementation of a SSE. It proposes to do away with the mandatory registration of section 8 companies for CSR contribution under the draft CSR Policy Amendment Rules, 2020 released by the Ministry of Corporate Affairs (MCA). The direct listing of a NPO on the SSE or the presence of a beneficiary NPO in the SSE directory will be sufficient for establishing credibility. The CSR capital must be allowed to accumulate in an escrow account for three years following which the account will be liquidated and spent under Schedule VII of the Companies Act.
Furthermore, the board or management of the corporate diverting CSR funds must not be related to the NPO to avoid conflict of interest. The SEBI panel also recommends that the MCA be allowed to authorize the trading of CSR spends between companies with excess CSR spends and those with deficit CSR spends. The SSE would be utilized for this trading exercise to enable better utilization of resources. The expenditure incurred by corporate entities for capacity building of the SSE will also be included in the CSR contribution by amending schedule VII of the Companies Act, 2013.
The Report has recommended that all revenue generated by stock exchanges through the SSE route be made tax-deductible. It has proposed exemptions of securities transaction tax on trades and capital gains tax for the sale of securities on the SSE. Furthermore, philanthropic donors must be allowed to claim 100% tax exemption on their donations to the NPOs that ‘benefit from the SSE’ including a provision for tax deduction in all investments in securities or other instruments of NPOs listed on SSE.
Corporate entities should also enjoy the benefit of deducting CSR expenditure that is attributed to the SSE from their taxable income. Finally, the Working Group has recommended that the 10% cap on income eligible for 80G deductions under the Income-Tax Act will be scrapped. First-time retail investors will be allowed to avail a 100% tax exemption on their investments in the SSE mutual fund structures subject to an overall limit of one lakh rupees. Lastly, the Report has also advanced a proposal of a five-year tax holiday to the FPEs listed on the SSE from the time of first listing.
The advent of the SSE bears immense potential to reinvigorate the social sector in India. It is encouraging that the Working Group has highlighted the pitfalls in foreign jurisdictions before advocating for a SSE and not endorsed a complete transplant of an existing model. The Covid-19 pandemic has led to a demand for higher spending in critical sectors of the economy in India. However, gradual economic liberalization has led to a consistent reduction in government capacity to cater to the social sector and created space for private players to step into the fold.
The flexibility in funding norms and the tax benefits offered could stimulate the engagement of private entities. Moreover, the emphasis on a pay-for-performance paradigm may also ensure that the SSE has the desired impact at the ground level. However, facilitating a steady flow of capital from a distressed private sector is likely to be an uphill task in the immediate future. Regulators must collectively generate an impetus for sufficient incentives that can offset the economic impact of Covid-19. The regulatory oversight exercised must not create an onerous burden of compliance on social enterprises to stifle investments.
– Rongeet Poddar