4.1 – Development Impact Bonds

Development Impact Bonds (DIBs) are a special financial arrangement used to fund social projects. How it works can be explained well by describing the role of each of the parties involved.

1. 1. Project and Goals: There’s a project that wants to achieve certain social goals, like improving education or healthcare. These goals are agreed upon in advance.
   2. Service Provider: The organization running the project, often a non-profit or a social enterprise, is called the “service provider.” They do the work to achieve the social goals.
   3. Outcomes Funder: The person or group wanting to support the project financially is called the ‘outcomes funder.’ They promise to give money only if the project successfully reaches its social goals.
   4. Risk Funder: To ensure the project can kickstart, another person or group, known as the ‘risk funder’, provides money upfront to the service provider. If the project succeeds and meets its social goals, the risk funder gets a small amount of money as a reward for taking the risk. Thus, they take the risk that the project might not achieve its goals.

1. 5. Independent evaluator: An independent evaluator is an expert from an outside organization. Their job involves setting the rules for measuring how well a project is doing and then checking if it meets those rules.  They are also responsible for giving an unbiased measurement of the social impact generated, a base report for the outcomes funder. 

The Technical Group on Social Stock Exchange presented an illustrative structure of a typical DIB as shown below –

• • The Cat I AIF – SVF (social venture fund) is a Social Impact Fund discussed in the previous chapter. 
  • The securities issued by NPOs in the form of ZCZP (Zero Coupon Zero Principal) instruments are for illustration only.

Who can issue DIBs and whether a retail investor can act as a risk investor or as an outcomes funder is still not clear. We need to wait and see how this evolves moving forward. 

DIBs are a way to bring in new money from people who want to support these projects, but they have to follow certain rules and be transparent about what they’re doing.

DIBs work best for projects that have already been proven to work and have clear goals/outcomes that are easy to measure.

Clearly, they may not work well for projects that require significant innovation to implement or where the outcomes cannot be linked to the inputs/interventions by the service provider. 

DIBs are not new in India. There are cases of – Educate Girls DIB and the Utkrisht DIB – that were discussed in the report of the SEBI Working Group on the social stock exchange. What’s new is how entities on SSE can make use of it. 

In a few countries, such as the UK, these are also called Social Impact Bonds (SIB). In the USA, impact bonds are better known as Pay For Success (PFS) projects.

4.2 – Donation through mutual funds

You all know how mutual funds work. It pools funds from various investors and invests those funds in securities such as shares and debentures in accordance with the objectives of the scheme.

Retail investors can donate to the entities on the social stock exchange through these mutual funds as well. Contributions are allowed only to organizations that have undergone certain scrutiny either 1) by the AMC or 2) by an intermediary.

Let us see the two ways money is donated towards social causes through a mutual fund. 

1. 1. HDFC Cancer Fund
      The HDFC Charity Fund for Cancer Cure was started to provide financial aid for treating needy cancer patients. The project provides financial aid up to ₹ 5 lakhs per patient. The fund works as follows: 

• • Soliciting funds: HDFC AMC solicits funds from social-minded investors who wish to donate returns made on their money, either partially or fully, to provide financial assistance to cancer patients. 

• • Invest in debt securities: The funds are then invested predominantly in debt securities, and the interest income arising from these investments is given to the Indian Cancer Society (ICS). 

• • Return of principal: Being closed-ended with a tenure of 3 years, the fund returns the principal to the investors every three years and raises a fresh round of capital.

    The shareholders receive a tax benefit under 80G of the Income Tax Act to the extent of the dividends they forego every year, subject to prescribed limits.

1. 2. Quantum Mutual Fund’s SMILE facility
      The SMILE facility of Quantum MF lets an investor decide to give a portion of their investment to charity. The fund works as follows:

• • An investor will consent to the percentage of investment that can be contributed to charity.

• • They can choose to support up to two NGOs that are checked and watched over by the “HelpYourNGO” Foundation (intermediary).

• • By automatically redeeming units, a contribution of 10% of the investment happens at the end of each year, specifically on September 30.

• • HelpyourNGO donates 95% of the contribution and issues 80G certificates to donors for the contribution.

Since such mutual funds mostly come in close-ended form(where your investment is locked for a specified period), their units will be listed on the stock exchange and available for trade.

We have to wait and see how this route will be used to fund companies on the social stock exchange.

Key takeaways:

1. 1. Development Impact Bonds (DIBs) are financial tools that fund social projects; ‘Outcome funder’ promises to give money, but only if the project successfully reaches its social goals. 
   2. ‘Risk investors’ in DIBs, who put money upfront, are rewarded with some return based on project success.
   3. Retail investors can also donate to the entities on the Social Stock Exchange through mutual funds. 
   4. AMCs or intermediaries will scrutinize the SSE companies before investing.
   5. As of now, these routes are not yet in effect. Both these fundraising routes will evolve as the SSE gains traction.

The post Modes of raising funds (Part 2) appeared first on Varsity by Zerodha.

In the previous chapter, we discussed who can raise funds on SSE. Here, we discuss the various modes of raising funds.

What do companies do when they want to raise funds from the public? They may issue fresh equity shares, or they may also issue bonds/debentures in the form of a loan.

The public subscribes to these offerings because they expect to receive investment returns.

However, when we invest in companies listed on the social stock exchange, the returns may not be monetary; instead, they come as social impact returns. Your investment may also be considered a donation. 

So, the methods and means of raising funds for organizations on the social stock exchange vary.

In this chapter, we will explore the various means of funding for NPOs (non-profit organizations) and FPEs (for-profit social enterprises) and the types of instruments they can issue.

Retail investors will be allowed to invest in instruments issued by both FPEs and NPOs. 

In this chapter (part 1 & 2), we discuss all the key instruments and methods through which a company on SSE can raise funds. We want to reiterate again that the social stock exchange is a new structure in India, and the rules and regulations may change as it evolves. 

The graphs below give you an idea of the instruments/modes available for NPOs and FPEs to raise funds via the Social Stock Exchange.

Equity and debt instruments are common across commercial and social entities. Here, we delve into other instruments/modes of fundraising and its functioning.

3.2 – Zero Coupon Zero Principal (ZCZP) bonds

Zero Coupon Zero Principal (ZCZP) bond is an instrument that a registered non-profit organization (not a for-profit organization) can issue to raise funds on the social stock exchange.

ZCZP bonds differ from conventional bonds. Let me break it down. When any commercial company collects money by selling bonds, it promises to pay a set interest amount at regular intervals and return the principal at the end of the agreed-upon time period.

On the other hand, ZCZPs, as the name suggests, have zero coupons (no interest) and no principal payment at maturity. An NPO can issue ZCZPs for specific social development projects/activities.

The minimum application amount to invest in ZCZPs is kept at ₹ 10,000 so retail investors can also participate. But note, as of now, that is January 12, 2023, the systems are not yet ready for a retail investor to invest. The minimum issue size when an NPO comes with a ZCZP issue is set at Rs 50 lakh, while the minimum subscription required from investors for ZCZP issuance to float is 75%.

Rules aside, ZCZP only promises a social return to the funder. The offer document for the issue will contain all the details about the issue, including tax benefits, risks, and other consequences of investing in their ZCZPs. 

What do you think is the risk of investing in ZCZP? As there is no monetary return, the main risk with ZCZPs is that NPOs will not deliver the social impact that they promised to create.

How will you know if the issuer delivers the social impact? It is through the disclosures that the NPO comes up with subsequently. NPOs have an incentive not to default. Why? If the NPO loses the investor’s trust, it will impact the donations in the future. 

NPOs generally raise funds at a project level. So, funding for future projects will dry up if the funds raised for past projects are not used efficiently.

Before investing, you can also do your due diligence about the issuer. The NPO coming out with ZCZPs has to display the following on its website – vision, target segment, strategy on how they plan to achieve the vision, governance matters, details of key management people, operations, financial statements, compliance, registration documents, details of past social impact and the risks. 

Just as you analyze a company before investing, performing basic due diligence before donating through ZCZPs is essential. After the bond’s tenure, the performance can be checked in its disclosures. 

When these bonds are issued, they will be listed on the stock exchange in demat form. These bonds will not be traded in the secondary market but can be transferred for other purposes, such as transfer to legal heirs.

Once the tenure is over, the bonds will be terminated, equivalent to delisting. 

The bonds may also be terminated when the object for which the funds were raised has been achieved and when the NPO submits a certificate to the social stock exchange.

If the NPO decides not to issue ZCZP to the public but only to limited donors, it can do so privately through social impact funds (discussed later) or other means.

3.3 – Social Impact Funds

Have you heard of Alternative Investment Funds (AIFs)? 

They operate much like mutual funds, but the key difference is that AIFs can invest in unlisted equity or a variety of structured products and the minimum amount you need to invest is ₹ one crore.

Why are we talking about it now?

That is because the regulator categorizes Social Impact Funds as a Category I AIF, which can invest in social ventures or social enterprises, including those companies that are listed on the social stock exchange. 

These funds used to be called social venture funds in India, but now they are called Social Impact funds.

The Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, will regulate these social impact funds.

The regulator has given some concessions to these funds –

1. 1. Generally, AIFs should have a corpus of at least ₹ 20 crore. But for a social impact fund, it’s only five crore rupees.
   2. Normally, you need at least one crore rupees to invest in AIFs, but for a social impact fund investing in social enterprises, it’s just 10 lakh rupees. And if the fund exclusively invests in businesses that are registered or listed on a social stock exchange, the minimum investment for an individual investor can be ₹ 2 lakh. 

Note that these minimum investment amounts will not apply to an accredited investor, who is considered a sophisticated investor with a special status under financial regulation laws.

So, if you want to support businesses that positively impact society, you can consider these funds. The only return one can expect is a ‘social impact’ return.

But why invest through a fund instead of directly picking businesses on the exchange? Well, it’s a bit like the difference between buying individual stocks and investing in a mutual fund. When you invest through a fund, they do all the research to make sure your money is used in the best way to make a positive impact. They would also charge a small fee for that.

Plus, each fund has specific rules about the kinds of businesses they can invest in. They must show that they make a difference by being accountable to investors through periodic disclosures. 

Key takeaways:

1. 1. ZCZP is an instrument designed for NPOs to raise funds from the public; no coupon and no principal will be repaid at maturity.
   2. ZCZPs will be listed on the stock exchange in demat form. These bonds will not be traded in the secondary market.
   3. Social Impact Fund is a Category I AIF, which can invest in social ventures or social enterprises, including those companies that are listed on the Social Stock Exchange.
   4. When you invest through a fund, they charge a fee for the research on what social entities to invest.
   5. Both these fundraising routes will evolve as the SSE gains traction.

The post Modes of raising funds (Part 1) : ZCZP and other instruments appeared first on Varsity by Zerodha.

Now that you’ve understood what a social stock exchange is from the first chapter let’s dive into what kind of entities can get on the platform.

The concept of allowing social entities to raise funds through a stock exchange is a game-changer. Not only does it offer entities access to a wider pool of potential donors, it also gives investors an assurance that their money is being put to good use.

Getting access to public markets means taking up some grown-up responsibilities. With increased transparency and disclosure requirements, the entities will now be accountable to investors for the ultimate usage of funds.

As per Sebi, two types of entities – non-profit organizations (NPOs) and for-profit social enterprises (FPEs) – can list on the social stock exchange. For your reference, you may check the NPOs listed on NSE here.

Unlike some other countries, where they keep NPOs and FPEs separate, India offers both these entities a shared platform.

Now, you might be thinking, “Hold up, why are we letting those profit-making entities (FPEs) join the social stock exchange?” Well, that’s the same question Nithin Kamath from Zerodha asked Hemant Gupta, head of BSE Social Stock Exchange.

Gupta said that FPSEs are becoming an integral part of the social development in India and excluding them would make the social stock exchange incomplete. “Further, when non-profit and for-profit organizations come together, they can deliver far more impact than either one of them can do individually,” he replied.

2.2 – Social Enterprise

Both NPOs and FPEs put together are called ‘social enterprises (SEs).’

To get on to SSE, they have to show that social intent and impact are its primary goals. There is a checklist to prove that.

Firstly, the entity has to engage in at least one of the 16 welfare activities that the regulator suggests. We are talking about things like eradicating hunger, promoting education, and promoting livelihoods for rural and urban poor. You can check the list of 16 themes here in the table.

*As and when the list is updated, the eligible activities for social enterprises also changes

Two, the entity must target an underserved or less privileged population. Or it could be regions that have recorded lower performance in the development priorities of the government.

Now, the third one is the real test. The entity should prove that it has been earning its revenue from or spending money on those who really need it.

How, you ask? There are again a few metrics to check-

About two-thirds of the entity’s average revenue in the preceding 3 years must come from providing welfare activities to the target population. The welfare activity must be part of one of the 16 themes mentioned above.

Or, it has to show that two-thirds of their expenditure, as calculated above, was spent towards the welfare of the target population.

Or, there’s one more card in the deck. The entity can prove that the welfare activities were provided to a population that makes up about two-thirds of their targeted customer base/beneficiaries.

Pretty long list, huh? There are other conditions as well for an NPO and FPE separately.

NPO, for example, has to be in existence for three years. It should have been registered as a trust, society, or a Section 8 company under the Companies Act 2013 or as stated. It has some minimum fund-raising (₹50 lakh) and spending requirements as well. 

On the other hand, FPE has to meet all the eligibility criteria that any other commercial entity does. It can be listed either on the main board or SME platform (Small and Medium Enterprises) or Innovators Growth Platform for young fast-growing companies.

Sebi wants to make sure there are enough safeguards and no illegal or bogus company raises funds from the social stock exchange. After all, investor protection is one of the principles on which the regulator functions.

Back to eligibility criteria, a few entities, despite having a social intent, cannot become part of the SSE platform. Think political or religious organizations, professional or trade associations, and infrastructure and housing companies (except affordable housing). Even corporate groups that are mostly funded by their parent companies don’t make the cut.

Keep in mind that some of these conditions could be tweaked as the SSE keeps growing and shaping up.

2.3 – NPO vs FPE

Investors will be able to differentiate between an NPO and an FPE entity on the social stock exchange, as they would be labeled differently.

To step onto the Social Stock Exchange (SSE), NPOs need to go through a registration process, unlike FPEs, who can jump right in for listing.

FPE has the flexibility to list its securities on the main board, SME platform, or startup platform and raise funds. 

On the other hand, once NPOs are registered on the SSE, they can choose whether or not to raise funds.

Remember, for most NGOs, funding is required at a project level. Whenever they want to raise funds for specific projects, they can do so by filing paperwork each time.

You might ask, “Why bother with registration for NPOs then?”

Registering allows NPOs to familiarize themselves with the rules of public fundraising. By registering, all NPOs agree to follow the same legal rules, which encourages them to be more open about how they get their funds. For-profit organizations would already have some idea of what listing means and entails. 

Registering serves as a good transition for NPOs, especially the smaller ones. Even if they don’t plan on listing anything right away, registering shows off their intent of social development to the public. Periodic disclosures and assessments also help improve governance in these organizations. Of course, this all comes with some extra compliance costs.

The registration for an NPO is valid only for 12 months and can be renewed based on meeting the eligibility criteria each year.

Once onboarded, NPOs and FPEs can raise funds using different instruments/modes such as – ZCZP bonds (Zero Coupon Zero Principal), donations through mutual funds, development impact bonds, and social impact funds – which we will discuss in the next chapter.

 Key takeaways: 

1. • Any organization that wants to get on to SSE has to prove ‘social intent.’ 
   • Non-profit organizations have first to register themselves on SSE. Once registered, they can decide whether to raise funds or not.
   • Registration on SSE will be valid only for 12 months. 
   • For-profit social enterprises can directly list on the mainboard or SME or Innovators Growth Platforms.
   • FPEs will be clearly distinguished from other commercial listed entities.

The post Who can raise funds on SSE? appeared first on Varsity by Zerodha.

We often feel like helping the poor, the underprivileged, or the oppressed with whatever little we can afford. A common question we face is who to donate to. We mostly doubt the legitimacy of the NGOs (non-governmental organizations) around us. This is where a Social Stock Exchange (SSE) steps in. An SSE will act as a bridge between the less-informed but willing donors and legitimate organizations doing real social work.

Hold on. Why are we discussing social organizations on Varsity? Because it will exist in the capital market, seek contributions from the participants in the capital market, and draw several parallels from the capital market. As market participants, we must know what SSEs are, what entities you can invest in, and what kind of returns you can expect. Therefore, we, Satya Sontanam and Vineet Rajani, are writing this module to introduce Social Stock Exchanges to the investment community. 

Starting with Brazil in 2003, at least seven countries established a social stock exchange (SSE). Not all have survived. The Indian SSE structure will draw some of their features, learn from their experiences, and improve upon their construct.

1.2 – What is a Social Stock Exchange?

A social stock exchange is a platform where social enterprises/organizations can raise funds from the public. Just like equity, commodities, derivatives, and small and medium-sized enterprises (SMEs), the social stock exchange will be a segment on the stock exchange. Both BSE and NSE have received approvals to run an SSE. Organizations listed on the SSE can be For-profit Social Enterprises (FPEs) and Not-for-profit Organizations (NPOs). 

1.3 – What is a social enterprise?

Organizations looking to register on the SSE must prove ‘social intent’. There is no legal definition of a social organization in India. SEBI has outlined 16 broad areas that represent social activity or intent. We will elaborate on the eligibility criteria of social enterprises in greater detail in the next chapter.

The two types of social enterprises, NPOs and FPEs, draw some similarities with commercial entities. The table below compares the three types of entities.

ZCZP, or Zero Coupon Zero Principal, is a new innovative security.  When you buy a ZCZP, you essentially donate your money to the issuing social enterprise. The ZCZP security in your demat account is symbolic and cannot yield monetary returns. As an investor, you can participate whenever there is a new issue from a social enterprise.

The government has recently extended tax exemption under section 80G of the Income Tax to the contributions made through ZCZPs on SSE. In the third chapter of this module, we will elaborate on other fund-raising instruments that could be issued on the SSE in greater detail.

Very few social enterprises in India function in a corporate structure. Their intent to list on the SSE will likely bring more structure to their functioning and reporting. However, their resources may be limited in understanding and carrying out the complete listing process and compliance obligations. Listing, in itself, could be an additional compliance burden on them. 

A capacity-building fund is being set up under NABARD to educate social enterprises on how to use the SSE and create awareness among the donors / general public. Four organizations, NSE, BSE, NABARD, and SIDBI, have collectively contributed INR 10 Cr as initial capital for the fund.

1.4 – The functioning of a social stock exchange

Just like you use a broker to trade in securities, you can use the same broker to buy instruments on SSEs. Because SSEs in India are a segment on commercial stock exchanges, they can use the readily available infrastructure of these exchanges. Therefore, it also becomes easier for the brokers to offer SSE instruments to their clients.

How is being a segment of NSE or BSE better than being a standalone exchange? A standalone exchange will have to enroll brokers. Only a few brokers might be willing to do this, as it will require additional compliance, deposits, and management focus. Separate marketing efforts must also be employed to raise awareness about SSE. Further, it will be one more account for investors/donors to create and maintain.

Being a segment on an existing commercial exchange means all existing brokers can, by default, offer SSE instruments. They won’t have to do any separate registration and compliance tasks. The broker can start offering these instruments on its website and app. So, they may not need to put too much effort into making investors/donors aware of the SSEs. Investors will discover SSEs as a segment more easily. They will be more accepting of the product as it will not require opening and maintaining a new account. 

Other functionalities, such as how the SSE instruments will be displayed on exchange, the frequency of market trading hours, bid-ask spread, market depth, etc., are not known yet. Issues related to brokerage, stamp duty, and transaction charges are being ironed out. There might be many more once the exchanges begin offering the various SSE instruments.

The securities you buy on an SSE will be stored in your demat account. ZCZP will be a peculiarity as it will have no returns or principal repayment. You are basically promised social returns on ZCZP, which may be difficult to quantify and standardize. The depositories are expected to carry ZCZPs at zero value as soon as they are credited to your demat account.

Return reporting aside, the not-for-profit social enterprises are not expected to deliver monetary returns. The for-profit organizations will also have to prioritize social impact. The challenge here is measuring the social returns or impact of the work these organizations would do.

The social enterprises listed on the SSEs in foreign countries have reported output measures like the number of people reached or the extent of geography covered. However, they have struggled to quantify the impact of their work. For example, when the goal is to educate marginalized communities about personal finance, you can tell how many people attended your workshops. What you cannot tell is how many of these people started managing their personal finances better after your workshops. 

This challenge is understandable because every social enterprise is looking to solve different social, climatic, or economic problems. Even in our example of personal finance education, it is difficult to follow up with the audience. Also, what are the exact metrics that you want to follow up on? These metrics will vary in every organization. The scale of operations and the level of impact each social enterprise intends to achieve will also vary.

SEBI has taken a step in this direction by requiring social enterprises to publish their Impact Score Card annually. The Impact Score Card must include details on the extent of the target social segment served, the intensity of impact on the median individual, and dimensions of income, social equity, and diversity.

1.5 – Regulations

The Securities & Exchange Board of India (SEBI) will regulate the social stock exchanges in India. It has also established disclosure requirements for the social enterprises listed on SSEs.

SEBI requires NPOs on social stock exchanges to publish an Annual Impact Report (AIR) every year, detailing the impact of their work. They will also have to publish a statement of utilization of funds periodically. The AIR will have to be audited by a Social Impact Assessor. Chartered Accountants, Company Secretaries, and Cost Accountants could act as Social Impact Assessors upon attaining certain certifications and meeting the eligibility requirements.

SSEs will be required to constitute an SSE Governing Council (SGC) to oversee its functioning. SGCs will have at least seven members, with at least one from each of the following categories.

1. 1. Philanthropic and social sectors, including public/private sector donors
   2. NPOs
   3. Information Repositories
   4. Social Impact Investors
   5. Social audit profession / self-regulatory organization for social auditors
   6. Capacity building fund
   7. Stock exchange

1.6 – Figuring out

As per the recent Economic Survey,  51 NPOs are registered on the BSE, and 50 (11 undergoing renewal) are registered on the NSE as of April 2024,. Nine NPOs have raised funds on SSE, amounting to a total of ₹ 12.4 crore. These projects span social projects in education, livelihood generation, skill development, etc.

The SSE is a new set-up. The challenges and collateral benefits or pitfalls may only be known as more social enterprises get listed and use the variety of fund-raising avenues available to them. The regulator and the exchanges will keep monitoring and adjusting their policies to streamline the processes. Therefore, our knowledge about SSEs will also evolve and refine over time.

In the next chapter, we will discuss what kind of social organizations can list on SSEs and what are the eligibility requirements.

Key Takeaways

• • A social stock exchange (SSE) will act as a bridge between donors and legitimate organizations doing real social work.
  • Organizations listed on SSE can be for-profit-organizations (FPEs) and not-for-profit-organizations (NPOs)
  • NPOs will have to register on SSEs before raising funds because fundraising might be a repetitive activity for them rather than just a one-time IPO-like affair.
  • NPOs are expected to raise funds using primarily Zero Coupon Zero Principal (ZCZP) securities.
  • FPEs will raise funds using equity and debt, similar to commercial entities.
  • A capacity-building fund is being set up to educate social enterprises on how to use the SSE and to create awareness among the donors / general public.
  • Social enterprises will have to publish an Annual Impact Report detailing the impact of their social work.

The post Social Stock Exchanges – An Introduction appeared first on Varsity by Zerodha.