Will Social Stock Exchanges (SSEs) find equity among investors?

When asked his view on philanthropy, Aristotle opined the following, “To give away money is an easy matter and in any man’s power. But to decide to whom to give it, and how large, and when, and for what purpose and how, is neither in every man’s power nor an easy matter.”

?Aristotle’s view on the subject, however, was restricted by the times he lived in; one can easily excuse him for not being able to visualize social stock exchanges (SSEs). If the Finance Minister’s plan comes to fruition, the answers to whom, how large, when and for what purpose can be easily answered. As stated in her speech, the exchange will serve as a platform for social enterprises and voluntary organizations to raise funds as capital, debt or as units like a mutual fund. The question that then remains is – how?

The term ‘stock exchange’ conjures up ideas of market forces and easy liquidity. While this may be easy to achieve in a bourse, the same may not necessarily hold true in for SSEs. The two differ fundamentally in the manner and goal of their functioning; they create varied incentives for stakeholder in their respective markets. In a bourse, the purpose is clear – personal enrichment through wealth creation, across liquid and non-liquid assets. As such, it becomes easy for the market to reach a quantitative number to value companies, as each of the players is looking at valuation from the lens of self-interest. In the case of an SSE, the incentives of the players are not as well defined and the broadly worded purpose of enabling fund raising for social sector players has left a lot to question.

The possible incentives and policies that can be enacted to encourage diversion of capital to the sector will be contingent on the legal structure of the fundee organization. Therefore, it is imperative to have legal recognition for each of the participants in the ecosystem beyond the colloquial narrative. Section 8 of the Companies Act covers all organizations that are broadly termed as Non-Government Organizations (NGOs), but the entire Act is conspicuous in overlooking social enterprises altogether. This is understandable given the comparatively recent rise of these hybrid companies, which work towards creating social change while having sustainable and profitable models. However, if the Finance Minister’s dream is to become a reality, this needs to change. The challenge in defining social enterprises is that too broad a definition such as in the United Kingdom, which postulates that the company should have a social purpose that isn’t necessarily its primary purpose, could lead to companies proclaiming themselves as social enterprises in hope of tax savings or cheap capital. Conversely, a narrow definition could leave eligible companies in the lurch and be antithetic to the goals that the SSE sets out to achieve. A B-Corporation approach, albeit more stringent with a clearly stated social purpose could provide direction in this regard.

Once the fundees have been adequately defined, the more important challenge is to create the right incentives for funders to put money in equities and bonds that provide low rates of return vis-à-vis the risk they offer. As it currently stands, the government has already created tax incentives for citizens to donate to registered NGOs and has mandated companies to spend a certain amount of their average net profit on social responsibility activities through the CSR rules. The incentives have been widely successful, attracting over Rs. 9,822 crores in the financial year 2015-16 alone. On the other hand, simply expanding on this and providing the same incentives to invest in a social enterprise is tempting but that would be a fallacy – it would only result in movement of capital away from voluntary organizations and towards social enterprises, where there is a chance of accumulating financial returns.

While policymakers need to be mindful of ensuring the incentives aren’t as plenty as they are for grants to non-profits, they also need to be conscious of the disincentives that may arise from not adequately addressing the low returns of the sector. The objective of these policy measures can be focused on either increasing returns or mitigating risk. Some measures such as social impact bonds, wherein the government indirectly funds the private funder if a social programme funded achieves beyond the defined impact, can create an incentive for the social entrepreneur to focus on outcomes and lead to better outcomes. However, while this makes capital more efficient, it does nothing to diminish the risk and doesn’t increase the returns to the funder. The government must focus on policies that achieve both ends.

For this to happen, the government and social sector players need to work together to standardize impact indicators within sectors and come up with a methodology to allow for easy cross-sectoral comparison of the indicators, which can be linked to the positive externalities created. The quantification of these externalities can be in the form of credits or karma points that can be accrued by funders based on the organization’s performance. Creating a secondary market for these karma points to make them transferable among funders, and allowing them to be sold back to the government for tax benefits can create the required incentives for equity capital to flow into the sector as it would diversify the risk across the twin purposes of financial stability and impact. Similarly, debt capital can be bolstered by incentivizing funders to come on as guarantors for part of the principal amount to be raised by the fundee by giving the guarantor tax incentives, whether the fundee defaults or not. By doing this, the policymakers can not only align the incentives of both the fundee and funder to ensure the financial stability of the social sector player, but also allow market forces to reach an equilibrium on the financial stability and impact prospect of the organization.

No matter how the government chooses to structure the initiative, it should nonetheless be lauded for the proactive steps that are guaranteed to give social enterprises the necessary shot in the arm. That said, the devil lies in the details and conflicting interests could result in the exchange becoming no better than a static listing of organizations. 

Article re-posted from my Medium account: https://medium.com/@sharangshah/will-social-stock-exchanges-sses-find-equity-among-investors-b6c9a35b0fed