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Securities

Solving The Problem of Information Asymmetry in Social Impact Investments: Analysing SEBI’S Proposed Social Stock Exchange

By Anurag Shah

Introduction

The Securities and Exchange Board of India on June 1st, 2020 released the working paper for the introduction of a ‘Social Stock Exchange’ (Hereinafter referred to as SSE).[1] As the working paper accurately states, this idea was introduced by our Finance Minister and has been under consideration since the last financial year. The concept of an SSE is to provide for a trading platform for raising capital as equity, debt, or mutual funds unit for devoting to social welfare.

In this capitalist-driven environment, it becomes imperative for the government to interfere and ensure that capitalism does not end up creating uncontrolled negative externalities for the society and environment in the form of lack of social inclusiveness or increased environmental impact. Examples of such interventions are social benefit legislation and mandatory Corporate Social Responsibility. For instance mandatory CSR has stimulated certain big corporations to work towards reducing negative impact on the environment. It is imperative to point here that India has always tried to balance development with improvement in the quality of life of society. This can be ascertained from the fact that India was the first country to have mandatory CSR for its corporate entities. The importance laid down by Indian polity on social impact and the support for the same given by the judiciary can be seen in the judgment of National Textile Workers vs P.R. Ramakrishnan and Others[2]; wherein Justice P.N. Bhagwati reiterated the importance of corporate entities performing their social obligations.

However, there is a primary difference between a company performing its corporate social responsibility and an organization whose sole motive is to bring about a social impact. The difference is that Companies undertaking CSR activities prioritize profit and consider social impact as a by-product. However, Non-Profit Organizations, Section 8 companies, and other such vehicles prioritize social impact as their goal. Given the fact that India is still at Rank 129 out of 189 countries in Human Development Index of 2019, it becomes imperative for the policymakers to provide an influx to these organizations working for a social cause. Therefore, SEBI’s idea of a Social Stock Exchange tries to provide this necessary influx to create more social impact.

SEBI’s proposed Social Stock Exchange

SEBI’s working paper initiates a systematic investment framework that would enable investors and philanthropic donors to contribute to the social sector spending in India. A recent trend has emerged where investors have responded to social and environmental degradation with concern and have shown positive willingness to change things for the better. Therefore, providing them with an opportunity to invest and contribute to this change would create a multipronged environment which would be beneficial for society as a whole. The idea put forward by SEBI envisages various models for introducing SSEs in the country. These include matchmaking platforms and alternative investment instruments listed on the already existing stock exchanges in India. The paper puts forward a very profound argument that the SSE should be placed within the already existing National Stock Exchange and the Bombay Stock Exchange to enable the SSE to leverage the already existing infrastructure, client information, and financial market data. The SSE envisions to form a new kind of capital or a new kind of financial system that would provide returns beyond the traditional ‘purely’ financial returns, with the social return being equivalent to or more important than financial returns. However, the roadblocks in forming a successful social stock exchange also need to be considered. The two major roadblocks are first, the information asymmetry existing between potential investors/philanthropic donors and organizations involved in social work, and secondly the lack of lucrative incentives for investors.[3]

The issue of information asymmetry

As stated earlier, a dominant roadblock in creating a celebrated stock exchange that could foster social development in the country is the information asymmetry between potential investors and organizations. Firstly, measuring the social impact that an organization has been able to produce is itself a difficult task given that such impacts cannot be calculated monetarily. Supplementing this is the difficulty to verify such impacts and to give verified information to investors. For instance, a profit-making entity can reduce information asymmetry in the market by disclosing its balance sheets and other similar financial statements. However, an organization working for a social cause cannot do this because the impact of a cause is, in itself,  a very subjective concept and might not be something that can be measured. Moreover, this asymmetry could not only drive away potential investors from the market but could also disturb the whole dynamics by presenting not-so-good organizations as lucrative investment options. However, under the working paper, SEBI has tried to counter this roadblock by a system of disclosures similar to that of the financial stock exchange.[4]

SEBI and minimum reporting standards for Social Stock Exchange

SEBI has tried to reduce information asymmetry between potential investors and the Social Stock Exchange market by bringing in the concept of minimum reporting standards for SSE. SEBI has also proposed for a new regulator to evaluate and oversee these reporting at SSE. The paper also states that the SSE would not only be a platform for capital raising for social impact but would also act as a ‘set of processes’ to filter out those NPOs that would actually create a social impact. Therefore, this would ensure that the organizations being listed would be those that could be eligible for the trust of the investors. This is ensured by the interpretation of  the term “social” in the paper. As per the paper, an enterprise is “social” not by virtue of satisfying a legal definition but by virtue of committing to the minimum reporting standard. This means that the paper envisages that even organizations that do not state the term “impact” in their primary objective could actually be working meticulously to create social impact. This move, in a way, reduces the information asymmetry because any organization reaching the listing process would endure strict scrutiny of SEBI to be considered as creating a social impact.

This is supplemented by the minimum reporting standards that ensure that the investors are given sufficient information about the activities of the organization and to provide for the proper flow of information in the market during the immediate term of the SSE. The minimum reporting standards comprise three sections. The first section is the Strategic Intent and Goal Setting. This section includes the vision of the organization and the societal or environmental problem that the organization is considering targeting. This is followed by the target segment the organization is considering and the solutions for the issue. Issues can be broadly classified into three headings namely, income, geography, and thematic issues. This section should also include the risks and the unintended consequences an organization sees in its idea.

This is followed by the second section which pertains to the social impact scorecard. This is a way to quantify the impact created by an organization. This would include outreach metrics to measure the reach of the program. This would be followed by a report on the depth and the diversity of the program. All these would be included in the annual report of the entity. The third section is about the general information that should be disclosed by the organizations. This includes the registration and the certificate under Section 12A of the IT Act (if not a section 8 company). The details about the highest governing body in the organization should also be disclosed. Along with this, there should be disclosure relating to funding received by the organization.

Conclusion

Therefore, using the system of minimum reporting standards, SEBI has tried to resolve the first roadblock in the path of forming a successful social stock exchange. This system will ensure that the potential investors and the philanthropic donors have all the required information to make an informed decision with regard to their capital being involved in the SSE. The second roadblock which is the issue of incentivizing the investors to invest in SSE has also been given due consideration by SEBI as the paper proposes incentives such as Tax exemptions both at the investor level and the securities transaction tax. This makes SSE a lucrative option for investors looking to invest in ideas trying to make a social impact. However, it is crucial to also consider that Indian investors are for the first time being exposed to a financial market whose motive is not primarily profit maximization and therefore it should also be borne in mind that it might take time for the SSE to become lucrative even after such incentives. The issue of information asymmetry has been handled effectively by the paper and it would ensure that there would be confidence in the market. And for any financial market to flourish, the confidence of the players in each other is imperative.

The author is a fourth year law student, currently pursuing their law degree from School of Law, Christ (Deemed to be University).


[1] Working Group Report on Social Stock Exchange, Securities and Exchange Board of India, (Jun 1st, 2020, Last Accessed on: 28th June, 2020), https://www.sebi.gov.in/reports-and-statistics/reports/jun-2020/report-of-the-working-group-on-social-stock-exchange_46751.html.

[2] National Textile Workers vs P.R. Ramkrishnan and Others, (1983) SCR 1 922.

[3] Social Impact Investment: Building the evidence base, OECD Report. (Add last date accessed),  https://www.oecd.org/fr/industrie/social-impact-investment.htm

[4] Rhodes, M.J. Information Asymmetry and Socially Responsible Investment. J Bus Ethics 95, 145–150 (2010).

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