[Shaurya is a student at Jindal Global Law School.]
The Securities and Exchange Board of India (SEBI) had recently laid out the framework for a Social Stock Exchange (SSE). By creating a platform that allows purchasing such securities, SEBI aims to provide nationwide accessibility of philanthropic funds to social enterprises (SEs). However, despite making changes to some existing regulations such as the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018, the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015, and the SEBI (Alternative Investment Funds) Regulations 2012 to facilitate the functioning of such an exchange, there are certain laws expressly dealing with corporate social responsibility (CSR) mandates that have been left untouched. Although this article recognises the need for bringing the reforms in the current regulations and thereby validating holdings in SSE to fulfil CSR mandates (as suggested by the expert working group of SEBI), it also points out the shortcomings of the proposed reforms. It discusses why mere purchasing securities should not amount to fulfilment of the entire obligation or even a larger proportion of the obligation, which could be implied from the reading of the said proposal.
Placing SSE in Existing CSR and Taxation Laws
The concept of an SSE was initially introduced by the Finance Minister during the budget of 2019-20. Later, in July 2022, SEBI released a framework for the SSE that would allow trading in securities of social enterprises, which can be listed here, including both non-profit organisations (NPOs) and for-profit enterprises which have ‘social intent and impact’ as their primary goals. The SEBI also introduced several types of securities which can be issued by the SEs, mainly:
● zero coupon zero principal bonds (ZCZP)
● equity or debt securities issued by Section 8 companies
● social impact funds (currently known as social venture funds)
● development impact bonds (DIBs)
● mutual funds
ZCZPs and DIBs are 2 key securities that are proposed to be allowed for meeting CSR obligations by the expert working group headed by Ishaat Hussain. As per Section 2(11) of the Companies Act 2013, NPOs do not fall under the category of ‘body corporates’ and face restrictions on issuing securities backed by equity or debt. The ZCZP, however, would be a purchasable instrument that could be issued by NPOs which would not give financial returns but social returns by promoting welfare in the society (including by way of eradication of hunger, poverty, malnutrition and inequality, or promotion of sustainable development goals / priority areas identified by Niti Aayog). On the other hand, the fundamental concept behind a DIB is that an NPO would receive funds after it delivers on some pre-agreed social metrics at pre-set costs/rates.
The working group was of the view that funding NPOs via SSE should be considered valid to meet CSR obligations under Section 135 of the Companies Act 2013. The implied rationale here is that as all listings on SSE would be subjected to a proper and equitable reporting standard, they should be considered equivalent to the entities mentioned under Companies (Corporate Social Responsibility Policy) Rules 2014. Further, it was proposed that “CSR funds should also be considered to act as outcome funder in case development impact bond. In this regard, there shall be a need to permit parking CSR capital in an escrow account for a period of three years. CSR capital, acting as an outcome funder, should also be permitted to grant to NPOs in DIB structure as an ‘accelerator grant’ –- a grant to fund non- program expenditure subject to 10% of the program cost”. Additionally, the provision of tax benefits under Section 80G of the Income Tax Act 1961 and the exemption to philanthropic investors from securities transaction tax for trades made on the SSE, and capital gains tax on long term capital gains accruing from sale of securities in the SSE were advised by the working group along with several other benefits such as allowing retail investors to avail a 100% tax exemption on their investments in the SSE MF structure, subject to an overall limit of INR 1,00,000.
These are reasonable recommendations as they would encourage corporates entities, institutions and retail investors to invest in such instruments. However, while making these suggestions, the working group ignored certain key fundamental factors which might even throw away the idea behind bringing in the CSR mandates.
Considerations not Considered by the Working Group
The reforms, as advised by the working group, have remained silent on what proportion of the total CSR funds could be contributed towards these securities. Ignorance of this aspect is actually way more concerning than it seems initially.
A sizeable proportion of the funding these social enterprises receive is in the form of CSR funding by the corporate entities. Further, although there are around 2 million social enterprises in India, it is practically impossible to have even 10% of them listed, especially considering the regulatory obligations prescribed in the framework (released on 19 September 2022) and by the technical group such as construction of remuneration policies and stakeholder redressal mechanisms, maintenance and disclosure of balance sheet (in accordance with the Indian Accounting Standards (Ind AS) under Section 133 of the Companies Act 2013), program-wise fund utilization for the year along with auditor’s report which SEs are bound to follow in order to issue securities. Thus, if the entire obligation can be fulfilled by the mere purchase of securities listed on the exchange, this situation would result in millions of organisations struggling to find funds for their social initiatives, deterring the running or establishment of such organisations as it would be unsustainable. Moreover, because SSE would only comprise those SEs which would meet its regulatory and disclosure requirements, companies might consider maximizing their holdings in SSE, factoring in the higher transparency and accountability.
The strict reporting standards would demand serious alternation in operating standards and functioning in general, which would be a strenuous task for relatively smaller organisations. Even though these changes aim for a positive outlook by promoting transparent and disclosure driven operation among SEs, they would come at a literal cost that would be hard to bear. Hence, it would further aggravate the issues for smaller SEs since companies would rather consider funding a project which is backed by securities listed on SSE than fund a smaller less renowned local enterprise. Hence, on one hand, companies would fulfil their social responsibilities by making use of a rather straightforward and simplified system, but on the other hand, most of the SEs around the country would fail to do so due to losing access to existing funds and resources.
Validating SSE to meet CSR requirements and availing tax benefits is indeed a much-needed reform that would incentivize investments in the SSE, and is one of the best ways to deploy unused CSR funds, but the silence on how much of the total funds could be allotted here is concerning. There must a be limit/cap on such investments and a specified percentage of the total fund which could be deployed in SSE. For instance, Canada’s social stock exchange, Social Venture Connexion (SVX) had limited the maximum amount that an (retail, institutional, or accredited) investor could invest in the SVX. The absence of such capping in the Indian SSE could lead to concerns regarding investor protection as well.
Conclusion
The proposal made by the working group would no doubt streamline the process of meeting CSR obligations, but a need for limitation/capping of these contributions is evident, or else SSE would be the path of deviation from the core ideals which fuel corporate social responsibility. Buying securities off an exchange to meet obligations would basically transform CSR obligation into just another regulatory formality for the companies. This would have a drastic impact on the existing social enterprises, as they would face a severe shortage of resources and would concentrate the resources in hands of a few, monopolizing the ‘social initiative’.
The recommendations made by the working group seem to be ‘corporate centric’ as they fail to account for the fundamental reality of the SEs and remain focused only towards simplifying the process of meeting CSR mandates and availing tax benefits. Therefore, there is a substantial need to look at these shortcomings of the proposed reform and fix its flaws before the SSE really comes to life.