This article appeared in World Economic Forum's Report, 'From Ideas to Practice: Pilots to Strategy' in March, 2014
Key Insights
- Social
stock exchanges, which provide liquidity, transparency and efficiency,
are mechanisms that can open up impact investment to retail investors,
and make it more attractive to mainstream investors.
- Strict
entry and reporting requirements for listing will help standardize
impact measurement and highlight social investments as legitimate
investment opportunities.
- Much work needs to be done to build a
vibrant public impact investing market; the article provides a roadmap
on how to develop enabling environment which includes issuers,
investors, and an ecosystem within which they can interact.
Today, impact investing is still the field of a few; to participate directly often requires a “sophisticated investor”
24, given the potential illiquidity of the investments
25. There are few retail investment opportunities available on a broader basis
26 for several reasons.
First, too few social enterprises (SEs) are truly
investment-ready. Major impact investing funds invest in only 1% of the
thousands of socially conscious companies that they evaluate.
27 The
low volume of deals results in high transaction and operational costs
for all stakeholders, curbing the sustainability of trading platforms,
impact investors and investees.
Second, measuring impact is more of an art than a
science, as it is still the early days of creating quantifiable and
comparable metrics. Tools such as the Global Impact Investing Rating
System (GIIRS) and Impact Reporting and Investment Standards (IRIS) are
steadily advancing standardized measurement and reporting.
28
Third, legal concerns related to tax structures and
uncertainties around exit strategies prevent impact investors from
making investment decisions.
29 Tax
issues become considerations in investment decisions because impact
investments can be made into both for-profit and not-for-profit
entities. As not-for-profit entities can benefit from special tax
treatment in their local jurisdictions, such as 501(c)3 status in the
US, tax implications of impact investments will need to be considered.
On the flip side, if a 501(c)3 is investing in a for-profit SE, it will
still have to pay capital gains tax. And, to retain its status, the
organization will need to ensure that investments fit under its bylaw
requirements and tax-exempt status.
While impact investing is still far from being an
accessible opportunity for the general population, investor demand for
greater liquidity (see Figure 12) and platforms such as Kiva and
Kickstarter make it clear that the potential for involving retail
investors in the sector is immense.
Figure 12: Degree of
Interest for Impact Investment Structures and Structural Features:
Investor Demand for Liquidity in Impact Investments Source: Global Impact Investing Network (GIIN), J.P. Morgan
A
social stock exchange, which can create a liquid market for private
investments that generate social and environmental value, is one
approach to unlocking a greater supply of impact investment capital.
30 From
a demand side, social stock exchanges can enable SEs to access global
mission-aligned investment from diverse investors. Moreover, a social
stock exchange platform can accelerate the transition towards consistent
and widely accepted social and environmental impact reporting.
Democratizing Capital Markets
Similar to regular
stock exchanges, social stock exchanges operate by facilitating the
listing, trading and settlements of shares, bonds and other financial
instruments. However, alongside traditional financial reporting, impact
issuers must comply with social and environmental impact criteria.
Listing on a social stock exchange enables financially sustainable
entities that address social and environmental issues, including SEs,
non-governmental organizations, impact funds and inclusive businesses,
to raise capital and expand their operations.
Social stock
exchanges provide a mechanism for listed companies to raise capital
through primary placements of securities, and liquidity to investors
through secondary trading of securities. Moreover, for all those looking
to make a difference, they provide the opportunity to purchase a
security. Thus, these exchanges open up impact investment to retail
investors, and make the field more attractive to institutional
investors.
Evolution of Social Stock Exchanges
The notion
of a social stock exchange has been developing for some time. In Brazil,
the Bolsa de Valores de Sao Paulo (BOVESPA) was the first philanthropic
donation arm of the Brazilian stock exchange. The South African Social
Investment Exchange (SASIX) was a similar philanthropic initiative with
the Johannesburg Stock Exchange.
A more recent initiative is
London’s Social Stock Exchange (SSE). Launched in June 2013, SSE
exhibits information on socially responsible companies already listed on
regulated stock exchanges. While shares cannot be bought or sold on
SSE, impact information is available on the currently listed 11
companies.
In North America, Social Venture Connection (SVX), a
Canadian platform endorsed by the Government of Ontario in 2008 and
approved by the Ontario Securities Commission in June 2013, recently had
a public launch at the Toronto Stock Exchange and is now gearing up for
issuances for small- and medium-sized social enterprises in Toronto.
However, shares cannot be traded on SVX. It is a direct investment
platform into not-for-profit entities.
31
Launched in July 2013, Impact Exchange, a collaboration
between Impact Investment Exchange (IIX) and the Stock Exchange of
Mauritius (SEM), is the only full-scale social stock exchange with an
ability to issue and trade shares and bonds of social enterprises from
across the globe. Impact Exchange is the third market of the SEM and the
only dedicated exchange board in the world for social impact
investments.
The Mechanics of Impact Exchange
Impact
Exchange works as a public trading platform, providing liquidity,
transparency and efficiency while also ensuring that the social and
environmental mission of the issuers is safeguarded and showcased.
32
Impact Exchange is operated by the SEM and regulated by
the Financial Services Commission, Mauritius. The SEM provides
infrastructure and regulatory oversight while IIX prescreens potential
issuers on the impact eligibility criteria and provides recommendations
based on this assessment to the SEM. IIX also monitors ongoing social
and environmental listing obligations of issuers listed on Impact
Exchange. All issuers must demonstrate positive social and environmental
impact to be listed on Impact Exchange.
Impact Exchange will
allow trading in securities (including shares and bonds) issued by
social enterprises and by funds that invest in social enterprises.
Social enterprises will be required to meet strict standards for
disclosing information about their businesses (see Figures 13 and 14),
their financial results and their social and environmental performance
in accordance with the standards laid out in the listing rules for the
Impact Exchange Board. The rules set out the minimum standards of
behaviour to protect investors and ensure the market is fair, orderly
and transparent.
Impact Exchange-listed companies have a general
obligation to disclose material information on a continuous basis and to
release specific information periodically.
Figure 13: Overview of Impact Exchange Entry Requirements as per the Listing Rules33 Source: IIX
Figure 14: Ongoing Listing Obligations Source: IIX
Impact-Exchange-listed
companies have a general obligation to disclose material information on
a continuous basis and to release specific information periodically.
Each
entity intending to list on Impact Exchange will be required to appoint
an authorized impact representative (AIR). AIR is an accredited social
adviser who will provide support through the listing process and ensure
that the issuer complies with impact requirements. The assistance of the
AIRs will boost investor confidence through independent verification of
the social and environmental impact of the issuer, and increased
transparency. Figure 15 shows the issuer’s steps to listing on the
exchange.
Figure 15: Issuer’s Steps to Listing on Impact Exchange34 Source: IIX
AIRs
include nominated impact advisers (NIA) and impact verification agents
(IVA). Entities are required to appoint an accredited NIA for providing
assistance and verifying the impact nature of the applicant prior to
listing. NIAs assist prospective issuers in preparing for listing,
meeting the market transparency requirements and fulfilling other
listing obligations. An accredited IVA must also be appointed to verify
impact reports at the end of each financial year. Only organizations
accredited by and recorded on the SEM Register may act as NIAs and IVAs
for the Impact Exchange Board.
Impact Exchange Ecosystem
As
with any regular listing process, professional advisers assist in legal
matters, accounting, valuation and due diligence. While a vibrant
impact investing ecosystem has started to emerge on a global and
regional level, this ecosystem will need to be developed, and advisers
will need to build expertise for (public) social capital markets.
AIRs
are key players in this ecosystem; they work directly with the issuers
to meet entry requirements and verify impact once an issuer is listed.
As the market develops, more traditional capital market players will
enter.
35
Investment banks, brokers and financial advisers will be
key to moving capital to scale, providing the market information to
attract and connect institutional and retail investors to SEs listed on
the social stock exchange. Only with these market linkages in place can
capital markets democratize, and individuals as well as institutional
investors use their investment funds to contribute to larger social
impact.
The Path to Developing a Vibrant Public Impact Investing Market
The
development of the public impact investing market is poised for a quick
take-off if concerted effort is made among intermediaries (investment
bankers, advisers and investment platform operators), the ecosystem
(lawyers, accountants and AIRs), policy-makers, issuers and investors.
These stakeholders should use the road map of the following actions:
Develop strong investment opportunities
- Intermediaries
need to work with potential issuers as well as investment and social
advisers to develop a strong pipeline of investment opportunities.
- Advisers
may also look to create innovative financial instruments that pool
together the financial needs of a group of SEs in a certain sector, and
structure a bond around that, such as the Water Bond or Health Bond.
- Policy-makers
and foundations may seek to coordinate support for the first issuers
and develop the templates for further issuances.
Develop an enabling environment for impact investing
An
enabling environment encompasses a fluid ecosystem, a ready and able
issuer, and willing and informed investors. For this to happen, much
advocacy and education is needed as well as alignment of incentives
among all the players. The list of priorities to initiate this virtuous
cycle would be as follows:
- Educate the ecosystem on the
specific characteristics of the public impact investment market and its
potential to build early engagement
- Provide incentives for the ecosystem to engage with first listings
These incentives can be driven by DFIs, policy-makers or foundations
that would like this space to get off the ground to help relieve their
burden of developmental support over time.
- Educate and provide
incentives (e.g. tax incentives) to retail and institutional investors
to build awareness and steer investor behaviour
- Enable ease of access to impact investment opportunities for retail investors by engaging a broad range of global brokers
- Provide
easier regulatory hurdles for issuances to be marketed in large retail
and institutional markets such as the US and Europe
- Encourage institutional investors to play a role in moving the market for the issuances on the exchange
- Encourage consistent social and financial reporting based on listing requirements
- Work
with information providers to establish information flows on investment
opportunities and trading information between the market, ecosystem and
investors
- Create the next generation of Impact Exchange participants by exposing them to simulation of the exchange academic institutions
Develop best practices and path to scale
- Evaluate and develop best-in-class reporting standards based on ecosystem, issuer and investor feedback
- Collaborate with intermediaries, ecosystem, service providers and policy-makers to share best practice
- Set
up a task force, after demonstration effect of the first issuers, to
develop and implement the roadmap to scale social stock exchanges –
focused on replication of the Impact Exchange model
- Document the
trials and successes in creating fully-functional social markets, and
disseminate them to the public via media and academic institutions
- Encourage similar exchanges to be set up at the local level across the globe
Conclusion: Unlocking Mainstream Capital
Social
stock exchanges ensure alignment of a company’s social mission with the
interest of its board and investors, making mission sacrifices that
give way to higher profit margins a concept of the past. The first
potential issuers – from mature SEs to international non-governmental
organizations – are currently preparing issuances ranging from US$10
million to US$30 million for listing. These securities will unlock
mainstream capital sources and give everyone a chance to invest in
social good.
When floated on Impact Exchange in the next few
months, the first issue will not only unlock mainstream capital for
social investment, but also set the stage for democratizing capital
markets – a much needed task for creating sources of equitable growth in
the world.