Thursday 27 June 2013

Can stock exchanges go social?

The idea of having social stock exchanges - listed companies making money while doing good - makes sense in fostering a caring world. But there are challenges.
By Willie Cheng, Published The Straits Times, 26 Jun 2013

FOLLOWING the 2008 global financial crisis, social stock exchanges to be set up in major financial centres were mooted. In essence, these exchanges allow for the trading of shares in companies that focus on social as well as financial returns.

However, the multiple postponements of launch dates suggest that the business case for this concept has been challenging.

While it had previously sought to launch the exchange in Singapore, Impact Investment Exchange Asia (IIX) has just announced that it will launch its Impact Exchange with the Stock Exchange of Mauritius. At about the same time, the British Prime Minister also announced the launch of the Social Stock Exchange (SSE) in London. In North America, the Green Stock Exchange, first targeted for end-2008, is now planned for 2014.

Social exchange redux

THESE recent initiatives should be distinguished from earlier social stock exchanges. The world's first social stock exchange was set up in 2003 in Brazil by Bonvespa. This was followed by the establishment of the South African Social Investment Exchange by GreaterCapital in 2006.

These early social stock exchanges were primarily philanthropic-based fund-raising platforms. The social investors were really donors without the ability to receive financial returns on their investments. Such exchanges merely facilitated matching donors with pre-selected social purpose projects and organisations.

In contrast, the social stock exchanges being promoted by SSE and IIX allow for the listing, trading, clearing and settlement of securities issued by organisations that create significant social impact. These securities could be shares, bonds, and other financial instruments. In other words, these social stock exchanges function like mainstream stock exchanges such as SGX.

The main difference between the two types of exchanges lies in the kind of organisations that are listed. Mainstream stock exchanges list commercial companies of all hues, all of which aim to achieve, arguably, maximum financial returns for their investors. In contrast, social stock exchanges only list companies that provide a good blend of social and financial returns. Such companies are usually of two types: social enterprises and inclusive businesses.

A social enterprise is a business with a social mission. There is some debate as to whether social enterprises should, in fact, be returning capital or dividends to their shareholders. Social stock exchanges, however, have adopted the broader definition. Indeed, if there were no financial returns to shareholders, there would be little reason to have secondary trading of these enterprises.

An inclusive business is one that benefits low-income communities by involving them in the business process in some way. It could be in the production process (thus creating sustainable livelihoods for poor communities) or in the consumption process (by creating affordable goods and services for the poor). With such companies, the investors that social stock exchanges attract and target are called "impact investors". In other words, they are those who value social impact as well as financial returns.

Why it may not work

A STOCK exchange is the epitome of free-market capitalism. It follows that a stock exchange, perhaps more so than the enterprises listed on it, should be economically viable and sustainable.

Over the long term, this means revenues (typically membership, listing and transaction fees) must cover the exchange's operating costs. This can only happen with a critical mass of listed companies, investors and transactions.

Therein lies the two-fold challenge for social stock exchanges.

First, the universe of target companies - the social enterprises and inclusive businesses - is not very large. They also tend to be small and medium-sized enterprises, lacking in both scale and, often, adequate profitability. Social enterprises, in particular, have typically been set up for, and are driven by, social missions, rather than business acumen.

Recognising this, IIX has created Impact Investment Shujog (Shujog being a Bengali word for "opportunity"). This is a platform to foster the growth and market readiness of social enterprises so that they can scale up and potentially be listed on its Impact Exchange.

Second, it is not clear that there will be sufficient impact investors and trades on these social stock exchanges.

Impact investing is an emerging asset class. In 2010, the Global Impact Investment Network estimated that the impact investment market could explode to US$500 billion by 2014; while JP Morgan estimated that the impact investment market for five major sectors could reach US$1 trillion by 2020.

At the time, these estimates generated much excitement. Subsequent studies, however, have pointed out the realities of impact investing and social enterprises. The current view is that such sky-high predictions will likely not be achieved.

One of the much-debated realities is whether impact investors can be expected to take a longer time to realise a financial return - and a lower financial return (compared to a typical commercial company) at that. The argument is that the requirement to provide both a social as well as a financial return necessarily means that something has to give on the financial return side. Indeed, impact investments have often been termed "patient capital" for this reason.

Another debate is whether socially conscious investors want or appreciate companies that deliver a blend of social and financial returns. One view is that most investors take a bifurcated view to charity and investments. An investor may be philanthropic and give money to charity - without expecting any financial gains. But when it comes to investments, he is focused on making as much money as possible.

Yet another reality is that the process of measuring social impact is new, fragmented and difficult to do. This is unlike the measurement of financial performance, which is rigorous and well understood. To address this, in 2010, 17 leading players in the field came together to set up a non-profit rating agency, Global Impact Investing Rating System, to provide comparable impact metrics based on a standard called the Impact Reporting and Investment Standards.

How it may yet work

SINCE the various players in impact investing seek to create a viable ecosystem that includes social stock exchanges, it would be instructive to watch where the mainstream commercial and investment ecosystem is heading.

There is already a movement in the commercial world for companies to be not focused entirely on economic returns. As part of this, regulators and other stakeholders are pushing for Environmental, Social and Governance (ESG) disclosures by companies.

Both globally and nationally, many such initiatives are in train. The most widely accepted international standard is the Sustainability Reporting Framework by The Global Reporting Initiative, a network-based organisation. The Singapore Exchange also recently announced that it may set up a Singapore Sustainability Index to guide investors in their stock analysis based on ESG factors.

The key point is that "social impact" is not a concept exclusive to social enterprises. Indeed, all companies can make some such claim. And ESG reporting will highlight that degree of social impact. Large listed companies such as Unilever, Disney and Aviva, for instance, have scored very high on comparative ESG ratings.

While ESG reporting is largely voluntary today, there are increasing calls for it to be mandatory. Indeed, the European Commission recently proposed accounting legislation that will require large European companies to disclose details of policies, risks and results in several ESG areas.

It is therefore just a matter of time before ESG reporting becomes pervasive in commercial companies. When this occurs, a separate social stock exchange will become less compelling. Social enterprises and inclusive businesses will be less differentiated and, if they qualify, they can then simply list on the main exchange.

Indeed, SSE requires that its member companies are first admitted to the London Stock Exchange while SSE focuses on the impact assessment. It also makes more sense when you consider that social impact is not static. A company's social impact can vary over time, and ESG reporting should capture these variations.

It would be a great achievement if the commercial world and mainstream stock exchanges fully embrace the social impact concept. Such a transformation should probably be the long-term objective of social stock exchanges in the first place.

Hopefully, a functioning and viable social stock exchange can be fully implemented soon. Otherwise, growing social consciousness and ESG reporting may supersede the need for purposeful social stock exchanges.

The writer is a former managing partner at management and technology consulting firm Accenture. He currently sits on the boards of several commercial and non-profit organisations. He is the author of Doing Good Well.

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