Burgess COMMENTARY

Peter Burgess

Are social stock exchanges the great equalizer to democratize development finance?

See also pdf 'Impact-Exchange_-how-it-will-change-investing' See also This past June, the world was introduced to two social stock exchanges.

In London immediately ahead of the G8 Summit, UK Prime Minister David Cameron announced the launching of the Social Stock Exchange designed to connect social impact businesses with investors looking to generate positive social or environmental change and return on their investment. Supported by the London Stock Exchange Group, the SSE already has 11 listed member companies.

“For years the London Stock Exchange has made London the home for private finance, today London can cement its place as the home for social finance too,” declared Cameron in his pre-G8 remarks. Around the same time, Impact Investment Exchange Asia or IIX announced its public trading platform for social enterprises, called Impact Exchange, which has been formed in partnership with the Stock Exchange of Mauritius.

The relationship with the Stock Exchange of Mauritius is strategic, according to IIX sources, and allows the exchange to expand its footprint into both Africa and Asia. The groups are anticipating the first issuance on Impact Exchange within the year.

Despite multiple launch postponements — and the difficulties of shifting the mindset of investors beyond profit alone – impact investing leaders said they believe these social stock exchanges are poised to both democratize development finance and make inclusive growth a reality in emerging economies.

A sector comes of age

The launch of these two exchanges shows how rapidly this sector is converging and evolving.

Just five years ago, impact investing was a fledgling concept and practice. There was plenty of buzz, but still many reservations over whether impact investing — defined as investments intended to create positive social or environmental impact beyond financial returns — could really mobilize as an industry and take off.

In a landmark 2009 report titled “Investing for Social and Environmental Impact,” the Monitor Institute constructively questioned whether leaders would come together to fulfill the industry’s promise or whether impact investing “would remain a small, disorganized and underleveraged niche for years or even decades to come.”

As impact investing gained momentum, optimistic analysts suggested it could grow to represent roughly one percent of professionally managed global assets, creating a market of $200 billion to $650 billion. According to a recent survey conducted by J.P. Morgan and the Global Impact Investing Network, impact investors plan to commit $9 billion in 2013, up from $8 billion in 2012. The idea of impact investing grew from recognition that the scale and complexity of global development challenges, including reaching base-of-the-pyramid populations, required significant amounts of private investment capital.

That reality has become increasingly apparent in the current age of declining public sector aid budgets and heightened private sector activity in emerging markets. Increasingly, more responsible private investors, retail and institutional, are seeking investments that produce social and environmental results alongside financial returns.

Development experts and social investors stress that impact investing also holds real potential as a supplement to philanthropy, as investors actively engage social enterprises and inclusive businesses positioned to deliver more sustainable development interventions.

As donation platforms like Kiva and Kickstarter have demonstrated, small donations from individuals can have a positive effect on poverty alleviation and global development. Social stock exchanges, such as SSE and Impact Exchange, allow the same individual to contribute to development through a small investment that can expand and multiply social and environmental impact.

Over the last couple years, impact investing pioneers such as the Rockefeller Foundation have sought to build a viable infrastructure and marketplace to facilitate deals and unlock impact capital. Public and private groups have worked together to create a more enabling policy environment and standardize impact assessments through tools such as the Global Impact Investing Rating System and Impact Reporting and Investment Standards.

To date, however, there has been no designated place for social businesses to raise social capital, nor has there been a trusted place for impact investors to identify and vet investment opportunities.

“The social entrepreneurship marketplace is hindered by a significant lack of transparency and major challenges in liquidity and exit opportunities,” said Randall Kempner, executive director of the Aspen Network of Development Entrepreneurs, a global organization which supports entrepreneurship and small and growing businesses in emerging markets. “These marketplaces offer the real hope of increasing the flow of capital to socially-focused businesses.”

How it works

Social stock exchanges operate like normal stock exchanges by facilitating the listing, trading, and settlement of shares, bonds, and other financial instruments.

The major difference is that, in addition to their traditional financial reporting, companies listed on social stock exchanges must also demonstrate their social or environmental returns.

Most of these companies are either social enterprises or inclusive businesses. Social enterprises are for-profit entities with a mission to address social, environmental, or otherwise development-related needs. An inclusive business, on the other hand, contributes to poverty reduction through the inclusion of low income communities in its value chain.

“The question has always been: How do we bring in more investment? The holy grail is Impact Exchange,” Durreen Shahnaz Founder and Chairwoman of IIX and Founder and Managing Director of Shujog told Devex during Impact Forum 2013, a global conference focused on exploring ways to leverage capital markets and finance to bring about social and environmental good.

“On the social enterprise side, Impact Exchange will allow these entities to raise more investment capital while valuing and preserving their social and environmental mission,” said Shahnaz. “On the investor side, the exchange will allow everyone who has the ability to spare a dollar to invest in social enterprises to do so. For the first time, you don’t have to be a wealthy person to make a difference with your investment dollar.”

Shahnaz added that Impact Exchange will also allow social enterprises to go public, meaning more investment can go into these organizations at an earlier stage with the ultimate view for exit. Pradeep Jethi, co-founder & CEO of the London Stock Exchange’s SSE, said he believes that public equities are essential to unlocking capital at scale. “The Social Stock Exchange is, above all else, an opportunities venue to stimulate capital formation at the early stage of the social enterprise development,” said Jethi, a former new product development manager with the London Stock Exchange.

“By increasing transparency and standardizing social and environmental impact reporting, we are reducing the cost of search and due diligence for investors all over the world.” For the SSE, member companies must already be listed on a traditional financial exchange, such as the London Stock Exchange, before their application is reviewed by an official admissions panel. The companies are also expected to produce formal impact reports on a regular basis which investors can access.

Jethi has big plans to hit 25 companies on the platform by the end of the year. Ultimately, he said he hopes to create a platform that lists at least 500 entities so the SSE can start creating more potent index products.

The road ahead

While optimism is high among the impact investing community, a number of challenges must be resolved before either of these exchanges can succeed and impact investing moves from niche to mass.

For example, investors cite too few investment-ready enterprises and specific projects. Some of the world’s most prominent impact investment funds tell stories of evaluating thousands of companies, but investing in only one percent of them.

Simply put, investors say, few social enterprises are at a level of professionalism to warrant a long-term private investment.

To change these dynamics over the longer-term, however, social enterprise incubators and accelerators are popping up across the world — such as Shujog in the Asia region — with the mission to help social enterprises build the systems and capacity that will make them more attractive to investors.

The sustainability of the exchanges themselves are also in question. While both the SSE and IIX cite pipelines of interested social enterprises and investors, there are valid questions over whether either exchange can establish sufficient revenue streams from membership, listing and transaction fees to cover longer-term operational costs.

Finally, despite the slow but steady development and adoption of GIIRS, IRIS and other standardized tools,impact measurement and reporting within sectors and across sectors remain thorny issues. From the point of view of investors, the primary functions of an impact measurement approach are the up-front screening or rating of prospective grantees during due diligence, ongoing performance-tracking once the investment has been made, and periodic results updates. Both exchanges seek to perform all these functions, but precisely how that will play out remains a question. ANDE’s Kempner expresses restrained optimism for the immediate future. “Are social stock exchanges needed? Absolutely. Have we reached a point where they will be viable? I hope so.” Shahnaz’s optimistic vision for the future of impact investing and social capital markets went even further.

“An effective social stock exchange can be the most efficient democratization tool — the great equalizer, the great vehicle to connect the power of finance with doing good in the public arena,” she said.

Shahnaz said she hopes and expects that in 10 years, the majority of the world’s population will be active participants in capital markets, using their investments to make a positive impact. “The capital markets and, in effect the world, is no longer ruled by decisions from a group of men from large financial institutions in the West, where the sole goal of pursuing profit dictates every move,” she said.

“Rather it will be a world where men and women, rich and poor, from east, west, north and south all are in equal footing being an active participant in capital markets to make it work for a better planet, a more equitable, livable planet for generations to come.”