Connecting CSR and social stock exchange

Allowing social stock exchanges to facilitate CSR funding of projects could catalyse change by improving outcomes

India is one of the few countries in the world where companies meeting specific criteria are statutorily required to spend a part of their profits on corporate social responsibility (CSR) activities. Section 135 of the Indian Companies Act, 2013, contains this legal provision, while Schedule VII to the Act lists out the activities that could be undertaken by a company under its CSR policy.

The CSR activities of Indian corporations have gained momentum over the years — both in terms of the absolute amount spent and the range of activities covered. According to Ministry of Corporate Affairs (MCA) data, the CSR expenditure during FY22 was Rs 25,933 crore.

The sectors covered under Schedule VII — social, economic, environmental, etc — besides being very wide, are also the focus of government budgetary spending.

During FY22, the combined CSR spending in health, drinking water and sanitation, education, environment, and rural development was Rs 23,000 crore, which amounts to 5.7 per cent of government spending in these sectors that year. 

Seeing the growing size of CSR spending, some people may be tempted to view it as an extension of government spending in those areas. There have been media reports critical of the skewed sectoral selection by corporations and the regional imbalance in CSR spending — being concentrated in a few states and neglecting the northeastern states in particular. Some have even suggested a role for the government in the planning, coordination and execution of CSR projects. This is the antithesis of the very concept of CSR. Corporations can’t be coerced to spend CSR funds to meet the government’s responsibilities and objectives.

That said, it would be reasonable to expect that CSR spending has an impact in the sectors and areas where companies choose to invest. There have been concerns, including thinly spread CSR spending across different sectors; lack of professional planning and execution; and corporations with small CSR amounts facing capacity constraints.

There is a need to look for ways to make CSR spending more meaningful. There could be cases where pooling of CSR funds of different corporations, and deployment of pooled funds by a professional fund manager in viable projects produce more desirable outcomes. Depending on their share in the pooled funds, corporations could even be represented on the boards of fund management companies.

Similarly, it would help to have a robust system in place for identifying credible non-profit organisations (NPOs), with proper track record, where the CSR funds could be invested. This would also reduce the monitoring burden on the MCA.

Against this backdrop, this article examines the potential and possibilities of synergising CSR spending with the mechanisms available under the social stock exchange (SSE). This was also one of the recommendations of the expert group set up by the Securities and Exchange Board of India (Sebi) to suggest the SSE framework.  

To give a brief introduction to SSE, the framework envisages fundraising by eligible NPOs listed on the exchange through innovative instruments such as zero coupon zero principal mechanisms (ZCZPs), social impact funds (SIFs) and development impact bonds (DIBs).

ZCZPs, notified as securities under the Securities Contracts (Regulation) Act, 1956, are instruments issued by an NPO that is registered with the SSE segment of a recognised stock exchange in accordance with the regulations made by Sebi. A ZCZP, with zero coupon and no principal payment at maturity, would promise social returns.

As for SIFs, Sebi has prescribed a framework for them under its alternative investment fund (AIF) regulations. These funds could invest in both NPOs and for-profit social enterprises.

In a DIB structure, a grant is made to an NPO after it delivers on pre-agreed social metrics at pre-agreed costs. The donor, who makes the grant when the social metrics are achieved, is termed as “outcome funder”. Given that the outcome funder pays on a post-facto basis, the NPO in the interim needs to raise funds to finance its operations from a “risk funder’’. A risk funder not only enables financing of operations on a pre-payment basis, but also undertakes the risk of non-delivery of social metrics by the NPO. The DIB structure on SSE would utilise a combination of investing in ZCZP and SIF.

With the aim of providing robustness to the SSE regulatory framework, Sebi has prescribed desirable disclosure and reporting norms for the participants. These include minimum requirements to be met by NPOs for registration with the SSE; disclosure requirement for NPOs raising funds through the issuance of ZCZPs; disclosure of an annual impact report by social enterprises; and the filing of a statement of utilisation of funds.

Corporations should be allowed to use their CSR funds for investing in various instruments under the SSE framework. Subscription to ZCZPs issued by NPOs or to units issued by SIFs are envisaged to be the instruments facilitating corporate funding. 

The CSR funds provider should be allowed to act as outcome funder in the case of DIB structures. This would require a need to permit parking CSR capital in an escrow account for a few years, i.e. until the materialisation of project outcome of the NPOs.

Trading CSR spends between companies may be allowed on the SSE. Every year, there would be companies that would spend more than the mandated minimum CSR amount, and those that are unable to spend due to various reasons. The latter category should be allowed to meet their commitments by buying CSR credits from the former, thereby avoiding paying penalties under the law.

To ensure a smooth and workable CSR-SSE connect, two issues will need to be sorted out. One of them relates to the proviso under section 135 of the Act, mandating the company to give preference to local area and areas around its operations for CSR projects. Naturally, the pooling of CSR funds of different companies in SIFs or investing them in ZCZPs of NPOs may not always ensure that. The companies located in the same area/industry zone could perhaps coordinate among themselves to obviate this problem to an extent. However, some tweaking of the law may still be needed.

The other thing to be ensured is that the smaller NPOs, which are unable to access the SSE, aren’t crowded out for receiving CSR funds. To obviate this, there could be a suitable ceiling on CSR funds, which can be channelled by companies to the NPOs registered with the SSE.

In conclusion, the government should allow the use of SSE to facilitate CSR funding of projects. This is not only likely to improve the outcomes of CSR spending, but also kick-start the nascent SSE mechanism.

The writer is a distinguished fellow at ORF and former chairman of Sebi