5.1 Social Stock Exchanges: Democratizing Impact Investing
- 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 investments25. There are few retail investment opportunities available on a broader basis26 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
Figure 14: Ongoing Listing Obligations
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
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.