BY RITU RAJ, THIRD-YEAR STUDENT AT GNLU, Gandhinagar

The Ministry of Finance, through a gazette notification dated 15th July 2022 has recognized Zero Coupon Zero Principal Instruments as securities within the purview of the Securities Contract (Regulation) Act, 1956 (‘SCRA’). Envisioned under the Securities and Exchange Board of India’s (‘SEBI’) Framework for Social Stock Exchange, Zero Coupon Zero Principal Instruments (‘ZCZP’) are bonds issued by Not for Profit Organizations (‘NPOs’) for the purpose of raising funds through the newly established Social Stock Exchange (‘SSE’) segment of authorized Stock Exchanges. They resemble debt bonds but are devoid of any interest or principal repayment obligation upon maturity. The investors can subscribe to ZCZP instruments to fund specified social impact projects and indicate the same on their balance sheets as assets. Upon maturity, they have to be written off from the books, and the investors are not entitled to receive any interest or repayment of principal. The return on investment is in the form of the social impact created by the underlying project.

NPOs  (except those incorporated under section 8 of the Companies Act, 2013) like Trusts and Societies are not defined as ‘body corporates’ under the Companies Act, 2013. Consequently, before this notification, the instruments issued by them for raising funds did not qualify as securities under the Securities Contracts (Regulation) Act 1956. This, coupled with their non-profit making nature and non-availability of audited information pertaining to the actualized social impact of the projects undertaken by them, impeded their access to institutionalized funding and restricted the maximization of their social impact potential. The Ministry of Finance, through this notification, has attempted to circumvent this impediment by facilitating the channelization of funds from the capital market to social impact projects through ZCZP.

This post analyses the scope of this newly introduced instrument by assessing the implementational framework, understanding the advantages it offers for both issuers and investors, and gauging the challenges it faces in the Indian market. It further attempts to undertake a comparative analysis of similar projects in other counties to understand the structural impediments and proposes measures to circumvent them while operationalizing ZCZP instruments in India.

Understanding Zero Coupon Zero Principal Instruments 

The NPOs demonstrating social impact and intent as their primary goal can get registered on the Social Stock Exchange segment of authorized Stock Exchanges and consequently raise funds from the capital market for specified social development projects by issuing ZCZPs. ZCZP comes with a maturity period which will usually be determined on the basis of the tenure of the specified development projects. Upon maturity, they can be written off from the books of the investors. While the investors are not entitled to any repayment from the NPOs, they bear a risk to the extent that the NPOs might not deliver the proposed social impact (Fundraising instruments and Structures for NPOs, Framework for Social Stock Exchange).

The issue of ZCZP will be regulated by SEBI under the Securities and  Exchange  Board of India  (Issue of Capital and Disclosure Requirements) (Third Amendment) Regulations, 2022. The NPOs must demonstrate expertise in the targeted areas through the social performance of past projects by making disclosures as mandated in Annexure III 2(d) of the SEBI’s Technical Group’s Report on Social Stock Exchange. The registered NPOs will be obligated to make periodic public disclosures with regard to the utilization of funds and the social impact of the projects vide realized annual impact report to ensure transparency. For the purpose of periodic disclosures, a new Chapter has also been introduced in SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 through SEBI Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) (Fifth Amendment) Regulations, 2022. These disclosures shall be based on the social audits conducted by institutions/firms of high standings in the domain employing auditors certified by the National Institute of Security Markets (‘NISM’). Moreover, to ensure authenticity and procedural fairness, a proposal has been made to establish a sustainability directorate under the Institute of Chartered Accountants of India (‘ICAI’) to act as a Self-Regulatory Organization (‘SRO’) for the Social Auditors.

While the trading potential of ZCZP instruments is limited, their recognition and the subsequent listing, coupled with the extensive disclosure requirements, offer an efficient framework of checks and balances. It enables an independent and objective assessment of the utilization of funds and the actualized social impact of the associated projects.  Consequently, this makes the functioning of NPOs transparent and mitigates the informational asymmetry between the issuers and the investors.

The availability of authentic impact assessment will aid both the retail and institutional investors in gauging the operational efficiency of the NPOs and help channel the funds to the ZCZP with higher social impact potentials. This will further incentivize the NPOs to improve their operational efficacy and adopt the best practices facilitating the maximization of the social impact of the projects funded through ZCZP. 

The ZCZP instruments offer a scope of altering the fundamental nature of funding social development projects by inducting liquidity. While the NPOs have no obligation to repay the principal received by them, the ZCZP can be freely traded on Social Stock Exchanges. The investors can liquidize their investment by selling it to other investors on the exchange who can continue to hold it as their contribution. 

Gauging The Challenges

The recognition of ZCZP as securities is a significant step toward the institutionalization of funding opportunities available for social development projects which continues to remain driven by individual philanthropists and state-sponsored grants. However, its successful operationalization faces multiple challenges.

Similar attempts to channel funds from the capital market for social development projects by enabling the listing of securities issued by NPOs were made in Canada, the United Kingdom, Singapore, Brazil, South Africa, Portugal, and Jamaica. However, they failed to take off in four (i.e., Brazil, Portugal, South Africa, UK) out of seven countries.

In the United Kingdom, a lack of investor and donor appetite for securities issued by social impact enterprises led to the failure of the Social Stock Exchange, which was founded in 2013 to facilitate social impact investment. The exchange had to restructure itself as a licensing body, and has been reduced to a directory of enterprises that have passed the social impact.

In South Africa, South Africa Social Investment Exchange (‘SASIX’) facilitated the listing and trading of securities issued for funding Social Impact projects. However, before closing its doors in 2017, SASIX could only raise $ 2.7 Million for 73 social impact projects in 11 years of its operation.

Similarly, a lack of interest on the part of investors forced Bolsa de Valorous Socioambientais (‘BVSA’), Social Stock Exchange launched by Brazil’s stock exchange Bolsa de Valores (‘BVS’) in 2003, to act as a facilitator between NPOs seeking funding and social impact investors to discontinue operations and make its official website inaccessible in 2018. After raising merely 2 million Euros in the first four years of incorporation, Portugal’s SSE Bolsa de Valores Sociais was also forced to shut its operations in 2015.

It is evident that the absence of mass transactions and a limited investor base made their business models unsustainable, as the exchanges could not generate the revenue required to cover their operational expenditures.  

Beyond the structural challenges of raising funds for development projects universally, in India, the proposed model appears skewed towards large NPOs with resources to comply with the required eligibility and periodic disclosure mandates. Effectively leaving out small/rural organizations working at the grassroots level out of its scope.

The Way Ahead

To materialize the envisaged goal of bringing ‘the capital market closer to the masses’ and democratizing funding for social development projects. It is imperative for the Government to navigate the challenges that might impede the successful operationalization of ZCZP Instruments in the Indian capital market. The Government needs to learn from the failure of similar models in other countries and adopt mitigating measures curated for the Indian context. There is a need to develop investor and donor appetite in institutionalized social impact investments and curate a sustainable revenue stream for the hosting SSEs.

Going beyond recognition of ZCZP as securities, there is a need to accept other recommendations of SEBI’s Working Group. The Group proposed incentivizing the investors through 100 percent tax deduction for investments made through ZCZP in NPOs with 80G certification, waiver of Securities Transaction Tax and Capital Gains Tax on investments in ZCZP, and making the Corporate Social Responsibility expenditure made by the corporates through investment in ZCZP deductible from their taxable income.

 The knowledge capital, credibility, and network of established exchanges can be leveraged to develop investor and donor appetite in the country. They can carry out awareness programs targeted at educating and sensitizing potential investors about ZCZP and curate networking opportunities for the NPOs.

Further, in the spirit of inclusive growth and financial inclusion, there is a need to establish a framework enabling small NPOs working at grassroots levels to raise funds through ZCZP. This can be facilitated by providing pro-bono services through the proposed Self-Regulatory Organization of Social Auditors within ICAI. 

Conclusion

The notification designating ZCZPs issued by NPOs as securities to enable the channelization of funds from the capital market to social development projects is a laudable step in the positive direction. It has the potential to circumvent the traditional ideas of collective risk aversion, valuation, and wealth maximization and materialize the goal of bringing the capital market closer to the masses by inducing the concept of social impact investments, financial inclusion, and sustainable economic growth. However, learning from the fate of similar initiatives in other nations, there is a need for the Government to ensure its successful operationalization by providing for efficient implementational framework, attractive incentivizing measures for investors, and structural support enabling the small/rural NPOs to access this avenue of fundraising.