The Corporate & Commercial Law Society Blog, HNLU

Category: Capital market

  • Institutionalizing Social Impact: The Scope Zero Coupon Zero Principal Instruments

    Institutionalizing Social Impact: The Scope Zero Coupon Zero Principal Instruments

    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.

  • Recent Trends: Measures taken by SEBI to Regulate the Indian Capital Market

    Recent Trends: Measures taken by SEBI to Regulate the Indian Capital Market

    By Nivedita Rawat, fourth-year student at AMity law school, noida

    Securities Exchange Board of India [“SEBI”] acts as a watchdog for the Indian Capital Market. The Board enacted by The Securities and Exchange Board of India Act, 1992 (“the Act”) has been accorded with comprehensive powers under the Act. The preamble of the Board describes its functions as to “protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto”. In addition to the intent behind the establishment of the Board, Section 11 of the Act lays down the functions of the Board that clearly illustrate “it shall be the duty of the board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit”. This provision exemplify that SEBI has been authorized to take any such measures that in its opinion would protect the interest of the investors and would aid to regulate the market. It’s the reason SEBI keeps on revising and updating by formulating new measures or directions that make securities market conducive, safe and friendly for all kinds of investors that include retail or institutional investors. In the past few months, during and after COVID-19 lockdown times, there have been some key instrumental measures that have been taken by SEBI, such as:

    1. Introduction of UPI and Application through online interface for Public Issue of Debt Securities

    SEBI, in its circular dated November 23, 2020 announced the introduction of Unified Payments Interface [“UPI”] Mechanism and application through online interface for public issue of debt securities. This system has already been in existence for issue of public shares since January, 2019 but is now made available for public debt securities through this circular issued by SEBI under Section 11 of the Act. The said mechanism is in addition to an already existing specified mode under Application Supported by Blocked Amount [“ASBA”]. It would be available for securities opening up for issuance from January 1, 2021 for applications up to a limit of 2 lacs. The concerned entities include National Payments Corporation of India [“NPCI”], UPI and the Sponsor Bank. 

    Analysis: The measure taken up by SEBI is extremely upright as it will make the process of subscribing to debt securities simple for the retail investors, will increase the investor base as the investors will have an option to use UPI interface to block their funds for debt securities during an issue through their brokers/intermediaries. Investing into debt instruments would be as similar as subscribing to equity initial public offerings [“IPO”] as it is now less time consuming and more digitalized. Although the initiative is bound to enlarge the responsibilities of the stock exchange, intermediaries and the sponsor bank, but the prevailing times call for such action as a physical process of issue of debt securities is not only a traditional approach but also make the process cumbersome altogether. Moreover, with the availability of UPI mechanism for subscription of debt securities, enhanced participation by the retail investors is anticipated. It is mainly because until now, the debt instruments had usually been subscribed by the high net investors and institutions, but such a measure by SEBI might change up the things and intends to encourage household investors to be a part of debt market as well.

    • Increased Efficiency of E-Voting mechanisms for Meetings 

    The Companies Act, 2013 mandates a company to provide e-voting facility to the shareholders. Section 108 of The Companies Act, 2013 along with Rule 20 of the Companies (Management & Administration) Rules, 2014 provide for such a facility. Additionally, regulation 44 of the SEBI (Listing and Obligatory Disclosure Requirement) Regulations, 2015 also contains provision to this regard.

    On Dec 09, 2020, SEBI released a circular directing the listed entities to provide e-voting facility to its shareholders. The mechanism called for a system wherein the shareholders will have an option to forecast their votes directly through their Dematerialized [“DEMAT”] accounts with the depositories which’ll forward their votes to the E-voting service providers [“ESP”]. The process would take place in two phases. First phase, wherein the shareholders can cast their vote either through the depository’s website or their DEMAT account. After which, the depositories will give the confirmation of the votes to the shareholders once received from ESP’s. In the second phase, the depository will set up an OTP system for login. For this new and much efficient mechanism, SEBI has also asked the Depositories and the ESP’s to provide helpline services to shareholders, whereas ESP’s have been directed to provide links for disclosures by the companies and the report of proxy advisors for investor’s awareness. 

    Analysis: The entire proposed mechanism aims to ease out the task of casting a vote for the shareholders. Elimination of registration with ESP’s and authentication from the point of depository will ensure security and legitimacy of the votes of shareholders. This is unlike the earlier mechanism in which the shareholders had to visit the ESP’s website to cast their votes with distinct usernames and passwords that created the voting procedure tedious and not very simple. The mandatory updating of key details of shareholders regularly by the stock exchange will also help the entities to be in contact with their users for one stop communication. Additionally, the initiative of providing the link for the disclosure by the entities and links to proxy advisor’s website etc.’ would guide the votes of the investors based on sound rationale, and would also enhance the participation in the e-voting process by the non-institutional shareholders or retail shareholders. 

    • Reclassification rules of promoters as public shareholders and disclosure of their shareholding pattern

    Rules for reclassification of promoters have been mentioned in Regulation 31A of SEBI (Listing Obligations and Disclosure Requirements) Regulation, 2015. On 23rd of November, 2020, SEBI released a consultative paper on the same that proposed a few amendments to the existing rules pertaining to promoter reclassification. It composed of the following proposed amendments:

    1. Promoters with shareholding up to 15%, seeking to reclassify should be allowed with shareholding’s status quo maintained.
    2. One-month duration for meeting between board & shareholders and for reclassification request to be put up before exchange.
    3. Promoters seeking reclassification pursuant to an order/direction of government or regulator should be exempted like reclassification pursuant to resolution approved under Insolvency and Bankruptcy Code, 2016. 
    4. Promoters seeking reclassification pursuant to an offer should be exempted from the reclassification procedure where intent for reclassification is mentioned in the offer letter which needs to be in accordance with SEBI Substantial Acquisition of Shares and Takeover [“SAST”] Regulations and Regulation 31A(3)(b) and 31A(3)(c) of SEBI(LODR) Regulations, 2015. 
    5. Pursuant to an offer, where the former promoters aren’t traceable by the listed entity or not cooperative towards it, exemption from reclassification procedures should be given if erstwhile promoters aren’t in control of the company and diligent efforts have been made by the listed company to reach out to them.
    6. Mandatory disclosure of promoters.


    Analysis: SEBI after having acknowledged the shortcomings of the existing process of promoter reclassification, has proposed amendments which seeks to bring orderliness in the procedure of promoter or promoter entity reclassification. There have been instances where a person is tagged as a promoter of a company in spite of having zero shareholding, this not only influences the choices of the investors but also makes the functioning of a company strenuous. The application of one-month deadlines between shareholder and board meetings and for putting up reclassification request by entity in front of exchange has been done with the intent to Fastrack the whole process and not to have any undue delay. The exemptions made for promoters pursuant to an offer have been proposed keeping in mind the procedural formalities which can be set aside in case where the stance of a promoter has already been clear or when it had been impossible to reach out to them. The disclosure of shareholding pattern by a promoter even in case of zero shareholding is a proposed amendment that aims to curb the companies from misusing the law due to existing loopholes. 

    Conclusion

    Additionally, SEBI has been looking forward to revamp the grievance redressal system for the stock exchange, for which the regulator issued directions to the Bombay Stock Exchange regarding the clients of the defaulting trading members. All inclusive, SEBI keeps on making endeavors to structure the capital market in the interest of the investors, listed entities or any stakeholders that form a part of the capital market. The recent measures have been taken keeping into account, the shortcomings of the laid down procedures or regulations of investing in share market. The Indian capital market should essentially avail the benefit of the rise in fintech like any other sectors of the economy. Depository participants such as Zerodha, Angel broking, Motilal Oswal Financial Services etc. have reported massive increase in the newly opened DEMAT accounts. It thus becomes imperative to have stringent securities law in place at the moment, especially when the number of retail investors have leapt up to record high numbers throughout the period of lockdowns in the country.