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One of the main hurdles that non-profit organisations (NPOs) face in securing financing from a wide variety of sources is the lack of robust information about their activities. To mitigate this problem, the establishment of a Social Stock Exchange (SSE) will prompt all NPOs that access capital through it, to submit to a minimum reporting standard.
The previous article has articulated the rationale for the SSE and described the minimum reporting standard. In this article, we describe what is to be gained by NPOs conforming to the standard – namely, access to finance in a variety of forms, owing to the higher quality of information that will now be available to funders.
NPOs take a variety of legal forms. Among these, Section 8 companies are permitted to issue debt and equity, and these could be directly listed on the SSE, which will be housed within an existing exchange. For most other types of NPOs, the possibility of issuing securities in order to raise funds is greatly limited under current regulations. These limitations will be substantially removed by the SSE, because any NPO that conforms to the minimum reporting standard will now be able to directly list a very simple class of financial instruments.
These instruments will be called zero coupon zero principal (ZCZP) bonds. Here, the funders will be essentially making donations and receiving ZCZP bonds in return, and these will be donations because the ZCZP bonds will promise no financial return whatsoever. However, the ZCZP bonds will promise a social return by way of the beneficiary NPO’s social impact, which funders care about. Therefore, the ZCZP bonds do carry risk but not the financial risk that conventional bonds carry. Accordingly, funders will be keen to channel funds only to credible and legitimate NPOs, which is the reason that the minimum reporting requirement is so crucial.
It is important to keep in mind that the trading potential of ZCZP bonds will be highly limited, as these instruments are essentially avenues for donation funding.
They do, however, represent an innovation over regular donations because by offering a route to direct listing on the SSE, they automatically come under the supervision of a highly competent regulator (i.e., SEBI) and this further bolsters the credibility and legitimacy of the NPOs that list such bonds (i.e., quite independently of the fact that listing also mandates a minimum reporting standard as discussed previously).
The SEBI Working Group envisions that NPOs that do the minimum reporting will also be able to raise capital via funding structures. The ZCZP bond is a funding instrument and not a structure. The essential difference is the presence of an intermediary in a funding structure. An intermediary is required for several reasons.
First, the funder who is interested in creating a particular kind of social impact may not know which NPO to turn to. Further, the funder or a group of funders may be interested in creating large-scale impact but NPOs that could deliver impact could be small and localised. That is, more than one NPO will have to be matched to more than one funder, and this kind of matching is best performed by an intermediary that has specialized knowledge about the social sector.
Second, the NPOs may require help with communicating their promise to the funder, i.e., they may need help with reporting, evaluation, etc. and an intermediary could provide this help. Third, the pool of capital available to fund social impact could be substantially increased if two different categories of funders could be engaged – those that would earn a financial return on their investments (risk capital funders), and those that would pay that return but only on condition that social impact has been achieved (outcome funders).
These kinds of pay-for-success structures are already quite popular in the form of Social Impact Bonds or Development Impact Bonds. The key innovation here is that of the intermediary, who would enable the coming together of multiple parties of each of the three types – NPOs, outcome funders, risk capital funders. This would ensure maximum traction as far as reach and depth of impact is concerned.
The SSE is envisioned as the venue that will originate such funding structures. The intermediary could be organised as a Mutual Fund (MF), or a Social Venture Fund (SVF). The HDFC Cancer Fund is an already-existing instance of the clever use of a mutual fund structure to fund social impact.
Similarly, SEBI’s AIF guidelines do not prevent SVFs from being used as pay-for-success mechanisms (as described in the previous paragraph), and even encourage their use as simple grants-in, grants-out mechanisms. But, surprisingly, no NPO has so far benefitted from such SVF funding.
The SSE’s contribution will be to mainstream the MF and SVF structures and bring them to many more funders and NPOs.
The above description offers only a glimpse of what is possible. There are many variations on the above structures that could be conceived, and it is hoped that as the SSE ecosystem evolves, those variations will come on stream as well.