Welcome changes to SEBI (Alternative Investment Funds) Regulations, 2012 but bottlenecks remain

While the Securities and Exchange Board of India’s (SEBI) attempt to institutionalize and reform its regulation of social venture funds over the last decade has been appreciable, there is still vast scope for improvement in the existing regime to fully tap the potential of social impact investment as instruments of social change, writes PRATIK PATNAIK.


THE American blues musician, Arley “Buster” Benton’s famed number Money Is the Name of the Game has been the venerated adage of business pundits from the time of the Greco-Roman slave economy, through the tyrannical age of the ‘Industrial Revolution’ to the current age of neoliberal capitalism.

As recently as in the 1970s, ‘star’ economists such as Milton Friedman argued that the sole responsibility of any business enterprise is to serve its shareholders and maximize returns for them without owing any obligations to society.

The chequered history of the 20th century has forced investors to rethink the philosophy of business, as they could no more divorce the impact of their wealth/investments and the last mile impact creation (or the lack thereof) of the investee business enterprise. While models such as philanthropic donations and corporate social responsibility have been around for a while, these dispensations have some inherent flaws. The capital in ‘donations’ or ‘grants’ is difficult to track as most donations are ‘no-strings attached‘ and the impact may not always be sustainable as the granted monies are spent without reinvestment and ‘creation’ of capital.

Social impact investments which aim at generating measurable social impact alongside a financial return have become the new instruments of change. They involve investing funds into enterprises, which have a positive social spillover effect, by the usual investment routes of equity/debt.

The Indian (in)experience

The SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) institutionalized and began the regulation of all kinds of residual investment funds (apart from mutual funds et cetera which were already regulated), including “social venture funds”.

Social venture funds are funds that invest primarily in securities or units of “social ventures”, which include trusts, societies, companies, venture capital undertakings and limited liability partnerships formed to promote social welfare, solve social problems or provide social benefits. These include: (a) public charitable trusts, (b) charitable societies, (c) companies registered under Section 8 of the Companies Act, 2013, and (d) microfinance companies.

Though social venture fund investments have grown from INR 24.30 crores (September 2013) to INR 1,105.55 crores (March 2021), the rate of growth is paltry considering the opportunities India, as a developing country, throws up. This is probably because policies relating to social venture funds are ‘raw’ or at best, ‘half-baked’.

The major policy concerns shall be dealt with later in this piece, after appreciating what has been done by SEBI recently.

Also read: Does India Need Just One Regulator to Protect All Investors?

Step in the right direction?

Social venture funds can also accept ‘grants’ in addition to accepting ‘investments’ which could be deployed by such funds in ‘social ventures’. Unfortunately, the minimum grant size which could be accepted was INR 25 Lakhs. This created hurdles for non-HNIs and other small ticket investors to invest even if they were keen.

Recently, SEBI has done away with such minimum grant size ushering in the possibility of spurring growth in the sector. Now, small ticket investors can make a grant which is lessor than INR 25 Lakhs.

However, this move is only a half measure. Most capital for developmental issues in the form of ‘grants/donations/contributions’ flows from developed economies. India strictly controls donation/contribution inflows from ‘foreign sources’ vide the controversial Foreign Contribution Regulation Act, 2010 (FCRA). Even when the AIF Regulations allow the receipt of grants by social venture funds, the same cannot be received by these funds from ‘foreign sources’ (such as foreign NGOs, philanthropic funds and impact investors) unless there is a specific approval under FCRA.

Further, it will be nearly impossible for social venture funds to receive this approval under FCRA as the FCRA is only equipped to allow ‘not-for-profit’ entities to receive funds from outside. This is a regulatory divergence that should be urgently plugged so that foreign grant monies can be received by social venture funds.

“(A)IF Only….in India”

If only I could read the signs in front of me

I could find the way to who I’m meant to be

Ah oh, if only

If only

If only….

American singer Dove Cameron’s song should be hummed by SEBI in the context of social venture funds in India. There are other structural issues with the social venture fund regime which are discouraging impact-focused investors from having any skin in this game. These include: –

Definition of “social venture” must be tweaked

It is pertinent to note that the way social venture funds are defined in the AIF Regulations,  only includes non-profit sector entities (like charitable trusts, societies et cetera) with the exception of the microfinance sector. This means that a social venture fund is prohibited from investing in a responsible impact-focused entity just because it is not “not for profit“.

This limitation is frowned upon by investors as they do not see ‘not for profits‘ as sustainable. The Bangladeshi Nobel laureate Prof. Muhammad Yunus of Grameen Bank fame has said, “money begets money”, and taking grants could be a bottomless pit.

SEBI should consider expanding the definition of ‘social ventures’ which would enable social venture funds to also invest in businesses that are for-profit but have a positive spillover on the society. Additional conditions could be built in the AIF Regulations in how to identify such ventures.

Minimum investment amount

While SEBI has removed the minimum ‘grant’ size restriction as highlighted above, it has not removed the restriction on the minimum ‘investment’ size of INR 1 Crore.

SEBI usually imposes such restrictions to protect investors’ interests to only encourage ‘sophisticated investors’ in putting their money in risky funds and to discourage mid and small-ticket investors. While the intention is deceptively noble but there cannot be a ‘one-size-fits-all‘ formula to deal with these concerns. An exception should be made for investments in social venture funds so that mid and small-ticket investments can be made in social venture funds.

Allow charitable trusts to invest in social venture funds in addition to government securities

Another colonial hangover that ruins our economy is restricting charitable/religious organizations in investing their surplus funds in certain purportedly ‘safe’ government securities and fixed deposits. One wonders what the use of such ‘investment’ is when the return on investment on such investment is much below the rate of inflation.

SEBI should allow such charitable/religious trusts to invest in ‘social venture funds’, at least, under the safe harbour of SEBI’s regulatory scanner. This will spur growth as dormant money from such organizations can fuel the national economy.

Restrictions can be imposed by tweaking AIF Regulations so that these organizations only invest in such social venture funds which make investments into portfolios that are aligned to the objectives of the investor organization.

Minimum fund size

An all-encompassing mandate for all kinds of AIFs, including social venture funds, is the minimum fund size of INR 20 crores, which means that unless a fund has INR 20 crores, it cannot make investments into social ventures.

This is way too onerous for a nascent impact market such as India. The minimum threshold should be lowered to encourage newer funds to consider this avenue.

CSR Funds into AIFs

The Companies Act mandates certain classes of companies to spend certain funds towards ‘social responsibility’, and has identified certain avenues, spending on which would satisfy this requirement under the law.

If such classes of companies are allowed to invest/make grants to ‘social venture funds’ as part of their corporate social responsibility requirements, it would bring in a lot of money into the sector.

Also read: In post-Covid world, India must fix its broken tax structure to achieve social and economic justice

Parting thoughts

According to the 2020 survey by the Global Impact Investing Network (GIIN), the global impact investing market size is worth $715 billion, and is expanding rapidly. Yet, India continues to be a marginal player in this domain.

The issues of our day cannot be only solved with dated ideas like government interventions; they must be tackled by creating capital and deploying it smartly. SEBI should urgently intervene in this sector before it earns the right to sleep over its laurels.

(Pratik Patnaik is a Delhi-based corporate lawyer. The views expressed are personal.)

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