SEBI’s Regulatory Amendments and Their Impact on NPOs – The RMLNLU Law Review Blog

By: Praseem Patel

INTRODUCTION

On 20th January 2025, the Securities and Exchange Boards of India (hereinafter ‘SEBI’) floated a consultation paper to review the framework for the Social Stock Exchange (hereinafter ‘SSE’). To broadly contextualise, SEBI proposed to amend the framework over the following grounds: (i) Amendments in SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (hereinafter ‘ICDR Regulations’); (ii) Amendments in specific provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (hereinafter ‘LODR Regulations’); (iii) Amendments in SEBI Circular dated 19 September 2022. The article seeks to conduct a systemic inquiry as to the economic justification of having such an institution, especially in light of the recommendations made by the Social Stock Exchange Advisory Committee (hereinafter ‘SSEAC’) in the consultation paper. While the recommendations provide for robust mandatory disclosures, the same should be done keeping in view the pathology of SSEs and NPOs as explained through a law and economics perspective in this article.

SOCIAL STOCK EXCHANGE

The genesis of SSE altered the perspective of stock exchanges traditionally known, as the entities it lists works towards financial gains through investment in social and environmental causes. This post-modernist form of capitalism fostered inclusivity and diversity in thought and practice of wealth creation. Brazil pioneered the SSE, followed by countries like UK, South Africa, Canada, Singapore, Portugal etc. In India, the first reference was made in the FY 2019-20 Budget Speech, with an objective to bring capital markets closer to social welfare objectives for inclusive growth. Any social enterprise—Non-Profit Organisation (hereinafter ‘NPO’) and For-Profit Enterprise (hereinafter ‘FPE’), working with the intent of social change, can be registered on SSE. The criteria to determine social intent are provided in the SEBI notification of Framework of SSEs published in 2022.

India has over two million social enterprises, with health, wellbeing and education being a dominant objective in around 40% of the social enterprises. Social enterprises face a lot of barriers—systemic, operational and financial. Therefore, the role of SSEs becomes more prominent to give a platform and assist in the financial aspect. SSEs have witnessed a steady growth in popularity across countries due to a rise in impact investment with a market of USD 1.57 trillion. In India, it was started with BSE SSE, and soon after NSE SSE was formed, both the SSEs have witnessed steady growth over the years and were able to successfully attract investors, as by December 2024, there were 111 NPOs registered in both the stock exchanges.

SSEs are met with mixed reactions in the world, there are stories of success and failures. For instance, while SSEs shows promise in India, the same was not the case with UK, as UK’s Social Stock Exchange was restructured into a new firm called Impact Investment Network, which was done to enhance the scalability of the social stock exchange and they are working towards the same by providing accreditation to impact businesses. Per contra, strong market fundamentals, regulatory support, and a clear alignment between social and financial returns led to SSEs success in Canada.

ECONOMIC JUSTIFICATION TO THE “SOCIAL INSTITUTION”

In a transaction taking place through an SSE, there are predominantly two parties—firstly, the investors who intend to invest in a social cause and secondly, the social enterprise which undertakes the responsibility to invest in a cause. Both parties interact with each other through a wider contractual agreement, which specifies the broad terms while some terms remain implied. Therefore, it becomes an agency between two parties.

The purpose of the stock market is to keep the capital running efficiently, which ensures the optimal allocation of resources. An ideal platform for the exchange of securities would be one which has: (i) no transaction cost involved in trading securities; (ii) the information requisite for decision-making is freely available to all participants; and (iii) there is unanimous agreement among participants regarding the implications of the current information for the present price and the expected future price distributions of each security. Then such a condition would be quintessential for investors and investment seekers as the prices “fully reflect” the available information.

Theoretical market conditions are not easy to practically replicate, yet treading towards them becomes an endless pursuit. SEBI, as a regulatory institution, works towards closing this gap of information asymmetry, which is inherent in the “agency cost model”. Mandatory disclosures are thus made part of the policy. Information efficiency is the ultimate goal, but the existence of the role of a stock exchange and mandatory disclosures can further be explained by the “accuracy enhancement model”, which suggests that by improving the accuracy and quality of mandatory disclosures, firms can lower their agency costs. It has been established that SSEs work towards enhancing the productivity of social enterprises. Firstly, productivity is enhanced through the provision of investments by impact investors. Secondly, productivity can be further amplified through the interactive social capital fostered on the SSE platform, where social enterprises cultivate stronger relationships with key specialised stakeholders, such as merchant bankers, brokers, and other SEs. These improved relationships facilitate learning and process optimisation in various ways, such as enhancing deal negotiations with banks and acquiring knowledge of industry best practices. Simply put SSE helps to connect demand and supply.

ENGAGEMENT WITH THE PROPOSED AMENDMENTS

The consultation paper provides for 32 proposals to reform the SSE framework; however, owing to the highly procedural nature of proposed amendments, the engagement of this article will be restricted to a few observations as follows:

As per Regulation 292A(e) of ICDR Regulations, NPOs cover charitable trusts as per Trust Act 1882, or relevant state statute; or charitable societies registered as per Societies Registration  Act 1860; or Section 8 companies as per Companies Act 2013. The ambit of entities covered is expanded inter alia to companies registered as per Section 25 of Companies Act 1956. The impact of expansion can directly be felt within the absorption of one of the biggest charitable companies in the country, e.g., Reliance Foundation, Tata Trust, etc., within its scope as the same were registered as per the 1956 Act. However, at this point, it is important to distinguish the disclosure requirements of an FPE from, SEBI related disclosure requirements, and while the FPE related disclosures is a statutory requisite for operating a Section 8 company or, its counterpart Section 25 registered companies; the SEBI-related disclosure requirements kick in when the NPO (including FPE) is registered with the SSE. Regulation 292F of ICDR Regulations provides for registration of NPO with the SSE, which SSEAC has advised to make time restricted, i.e., a time limit of 2 years will be provided for NPOs to list projects. The issue with corporate-funded FPEs is that they do not require funding from retail markets; their purpose is to cater to the CSR obligations of their parent companies and, thus, would never be listed and just have to comply with the statutory provisions of the Companies Act.

Nevertheless, the amendment will allow a range of other companies registered under Section 25 of the Companies Act 1956 to raise funds from the SSE by listing their securities. The issue will, however, be the reporting of such listings so that information travels to investors. Listing of securities of a company going through the process of IPO serves a very important economic interest of the market and investors and, thus, is widely reported in media. Will the reporting of an NPO’s listing be met with the same enthusiasm as the IPO of any other non-Section 8 or 25 Company? It is a subject of empirical inquiry. The self-serving outlook towards the stock exchanges makes the idea of SSE listings an anathema which might be met with obscurity even after the amendments.

The social-purpose finance ecosystem that SEBI attempts to create is based on disclosure-driven procedures, the same SEBI is attempting to attain through bifurcating self-disclosures into financial and non-financial aspects (Proposal 14), amending the provision of Social Impact Reporting and broadening the ambit of reporting by incorporating significant non-listed projects within the existing framework whereby only listed projects used to be reported in terms of their impact over the society (Proposal 16). Addition of Project/Programme Proposal Issue at the time of making primary disclosures for raising funds on SSE, which has the standard operating practices to engage with a project (Proposal 21). Similarly, 23 to 26 increased the requirement for additional documents like certificates, licenses, additional financial statements, Audit reports filed with Income Tax, etc., to be produced by the NPOs. Through all of these measures, SEBI attempts to overcome the agency problem and enforce the contract between the investors and NPOs with more rigour, as investor’s confidence in the trading ecosystem is of vital consequence.

A PYRRHIC VICTORY?

The mandatory disclosures come with high costs, the consultation paper also mentions, “Impact Reports also come with a cost… huge opportunity costs.”, NPO on an institutional level absorbs transactions, thus reducing the transaction cost involved in traditional investment in social causes i.e. search cost, negotiation cost, contracting cost and enforcement costs, SSE would be the platform where investors can locate the targets, ‘programmes’ their ideals resonate with thus reducing the search cost, other service providers associated with SSEs would facilitate the contracting costs, and by broadening the scope of inquiry through enhanced disclosure requirements, SEBI effectively mitigates enforcement costs, as it mandates that NPOs furnish all necessary documentation to facilitate investigations and inquiries in the event of any agency-related breach. An NPO, while absorbing the “transaction costs” of an investor, has proven its utility for the market, however, due to the existence of an agency in this transaction, the governmental regulatory body provides for mandatory disclosures, leading to a consequential increase in the cost of operations and the “opportunity costs” for the NPO. The transaction cost saved by an investor is bled by the NPO to meet the disclosure-related costs, thus making it a pyrrhic victory. Hence, the delicate balance should be maintained to keep the market running efficiently.

CONCLUSION

SSEs were introduced to democratise and popularise impact investment; however, over the past decade, many SSEs have failed to achieve the desired outcome as SSEs cater to different classes of investors who participate with a non-conventional goal of societal change. Over the years, methods have been devised to quantify the impact thus created in addition to bolstering the reporting mechanisms to overcome the information asymmetry inherent in the agency contract. However, the same comes at the cost of increased transactional costs. The imbalance between the same led to smothering either the investors or the NPOs, thereby failing the entire idea of formalised impact investment. Balance runs the market efficiently, as established in the article.