Abstract

In the context of a raging pandemic and climate change, renewed attention has been granted to the notion of sustainability. This has necessitated the corporates to embrace ESG in their respective governance verticals. In such backdrop, this Blog Post provides an overview of the rise and need for ESG investing in the contemporary context and summarises the meaning of Social Impact Bonds. Further, the company law landscape is explored to precisely dissect the question – is the existing framework under the Companies Act, 2013 sufficient to permit private capital inflows for social causes through new age instruments like Social Impact Bonds? A structure framed under the aegis of corporate social responsibility is then proposed and argued for. The manner of approaching such an undertaking is also laid out.

1. Introduction: Investing with ESG at its Pivot 

“SDG,” “ESG,” and “impact investing” – these buzzwords gained popularity and emerged as commonly known characters of the COVID-19 pandemic era. While the concept of sustainable development has long been accepted as a unanimous goal of humankind, its multifaceted undertones continue to be explored. Driven by factors like (a) the epochal jump in private equity transactions; (b) increasing inequities in the global population; (c) enlargement of mandates of corporations; and (d) the palpable ramifications of an interconnected order; sustainable development has taken the centre stage. In this context, the “Berle-Dodd” debate appears (more or less) settled and the social responsibility of corporates well established. 

Given their impact, modern financing instruments with Environmental, Social, and Governance (hereinafter “ESG”) at their respective nuclei, are being devised. ESG investing is a strategy deployed to assess the performance of corporates on metrics other than purely financial ones. Apart from allowing investors to consciously contribute to the enhancement of environmentally and socially oriented issues, ESG investing strategy also promises profitable returns. For this purpose, the United Nations (hereinafter “UN”) had formulated the “Principles for Responsible Investment” in 2006, based on which a blueprint was subsequently released in 2017. Through the six principles so formulated, the UN introduced the concept of fiduciary duties of investors on whom obligations such as: incorporating ESG in their investment analysis and decision making, seeking appropriate ESG-related disclosures, implementing the said principles, etc., among others, were levied. 

Considering the backdrop laid out above, this post explores the relevance of Social Impact Bonds-one of the tools aimed at ESG investing, in the Indian context. To this end, the viability of SIBs vis-à-vis the existing company law regime has been discussed.

2. Overview: What are Social Impact Bonds? 

A Social Impact Bond (hereinafter “SIB”) is one such modern financial instrument, the keystone of which is ESG. An SIB is a “pay-for-success” instrument to raise finance for public-sector issues, identified to create effective solutions to address the same. Generally, a “pay-for-success” instrumentinvolves the following key parties: 

a. Outcome payers – Usually, the party responsible for identifying the social issues for which solutions are being sought shoulders the obligation of paying returns if the pre-set outcomes are achieved. 

b. Service providers – Commonly, service providers are bodies/organisations with sub-agencies or departments that possess the tools of ideation and execution to attain data-driven solutions for the identified social issues. 

c. Investors – Investors have adequate capital who provide (ordinarily, upfront) funding to the service providers. The repayment due to these persons is interlinked with the project’s success, for which a “pay-for-success” instrument is floated. 

In respect of the SIBs, the “outcome payers” are typically governments or governmental bodies (like central/state governments, municipalities) that call the service providers’ and investors’ attention to socially-oriented issues. Agencies responsible for implementing a socially oriented project operate as “service providers.” Further, persons with access to substantial capital pools, who are keenly focused on both the financial and non-financial returns of the outcome generated, act as the “investors.” 

In this light, the pertinent issue to be appraised becomes – whether the existing framework under the Companies Act, 2013 (hereinafter “the Act”) and the rules legislated thereunder is sufficient to encourage their deployment as a medium for Corporate Social Responsibility (hereinafter “CSR”).

3. SIBs in the Indian context: How can Companies imbibe SIBs in the corporate ecosystem for CSR? 

Concerning certain ESG parameters, a disclosure-based scheme has been adopted by the Indian financial market regulator, i.e., the Securities and Exchange Board of India (hereinafter “SEBI”). TheBusiness Responsibility and Sustainability Report charts out the format for the top 1000 listed entities (by market capitalisation) to divulge information for sustainability reporting. Furthermore, the SEBI has constantly assumed the mantle of laying down guidance for green debt securities in2017 and2021. Contrastingly, while SIBs have been in the global market since the early 2010s and have proven successful in the United Kingdom, the United States of America, and other countries, adequate dialogue on their adoption in India is still wanting. Arguably, a pure disclosure-centric regime may not be sufficient to achieve the goal of sustainable development, i.e., a concept the undertones of which, in turn, require fulfilment of other objectives (like inclusive development). 

Per the Financial Budget for FY 2022-23 (hereinafter “Budget”), the governmentagain emphasised on its reliance on blended finance as a suitable avenue for raising capital for “green” ventures. To this end, the Central Governmentproposed issuing sovereign green bonds in the Budget. This is unsurprising given the enhanced governmental focus on “green financing”in the last decade. Notwithstanding, one of the other key objects of the 2022-23 Budget was “inclusive development.” It was only last year, i.e., in 2021, that the municipal corporation of Pimpri Chinchwad, a city in Maharashtra known for its auto industries, entered a Memorandum of Understanding (MoU) with United Nations Development Program (UNDP) India to design India’s foundational SIB. Thesocial cause that this project is concentrating on is affordable, accessible, and high-quality healthcare to the citizens of Pimpri Chinchwad. An indispensable aspect of sustainability is inclusive development, which, inter alia, requires development across sectors (like healthcare, education, housing), classes, communities, and other areas. Fittingly, SIBs would prove instrumental in catering to the objective of inclusive development. 

Addressing the question of whether the extant structure of the Act is expansive enough to allow eligible companies to undertake CSR by directing the earmarked capital through SIBs.Section 135(1) of the Act obligates every company possessing – (a) net worth of Rs. 500 crores or more; or (b) turnover of Rs. 1000 crores or more; (c) or a net profit of Rs. 5 crores or more; during the immediately preceding financial year, to constitute a Corporate Social Responsibility Committee of the Board, composed in the manner so prescribed. In terms of Section 135(3), the Corporate Social Responsibility Committee (hereinafter “CSR Committee”) is required to formulate the CSR policy for the concerned company. The said CSR policy of the concerned company, subsequently approved by the Board of Directors, must indicate the activities to be undertaken in the areas or subjects as prescribed in Schedule VII of the Act.Schedule VII of the Act details a list of potential activities – inter alia, health, sanitation, promotion of education, rural development, slum development, disaster management, protection of heritage/art and culture. Evidently, Schedule VII enumerates a cross-sectoral list that is comprehensive enough to include CSR projects on a myriad of social causes. Such cross-sectoral development is crucial even for achieving specific Sustainable Development Goals (hereinafter “SDGs”). 

Governmental bodies can, hence, acknowledge investment so made through SIBs under the aegis of CSR, subject to compliance with the conditions stipulated in the Act and Companies (Corporate Social Responsibility) Rules, 2014 (hereinafter “CSR Rules”). Amendments to the Act, where necessary, can be carried out to this end, similar to those introduced for including contribution to Clean Ganga Fund, Swachh Bharat Kosh, and Prime Minister’s Citizen Assistance and Relief in Emergency Situations (PM -CARES) Fund,in Schedule VII. Since CSRcan be implemented directly or through implementing agencies, the task of execution of a given CSR project can be outsourced to an entity suitable to qualify as an implementation agency under the Act. As explained above, such entities would be “service providers” for an SIB. Moreover, as the SIBs are generally designed in tandem with a governmental association, companies would feel more confident donning the role of investors vis-à-vis SIBs. In addition, independent evaluation of the performance of these instruments makes their monitoring more convenient and objective. 

As per Rule 7(2) of the CSR Rules, the surplus generated from CSR activities should not form a part of the business profit of the company concerned and should be – (a) ploughed back into the same project; or (b) transferred to the unspent CSR Account (under the Act) and spent in pursuance of CSR policy and annual action plan; or (c) transferred to such funds, as prescribed under Schedule VII; within six months of the expiry of the financial year. Therefore, within a given financial year, the CSR Committee can earmark the recommended proportion of available corpus for investment in SIBs. Depending upon the success of the SIB so opted, the profits accruing from such investment, if any, can then be ploughed back and recycled for the end of CSR. This way, the eligible companies can be incentivised to invest in public-sector-oriented projects carrying the potential of generating profits. Given their potential of yielding profits from a CSR-oriented investment, such a recycling mechanism of the profits and surplus amounts generated via SIBs would go a long way to cultivate corporate interest in social responsibility, which for the major part, continues to be perceived as a mere legal obligation. Arguably, such an ecosystem may prove conducive for encouraging corporates to assume more active roles in the social sphere. Hence, SIBs could be utilised to secure corporate funding under the mandatory requirement of CSR for an identified project. 

The potential benefits for permitting corporate spending on SIBs as a CSR mandate are, hence, manifold and include the following: 

a. Increased investor confidence where SIBs have governmental approval. 

b. Access to enlarged pools of the capital of private persons made available for CSR.

c. The benefit of the expertise of service providers equipped with the necessary tools for the execution of a given project.

d. Independent evaluation of the performance of the SIB, lending objectivity to the success of the CSR project.

e. Recycling surplus/profits and self-feeding operation of CSR-related funds of the concerned corporate.

The rationale for routing SIBs under the CSR requirement, as argued for above, also resonates with one of the recommendations of the Alternative Investment Policy Advisory Committee (hereinafter “AIPAC”), which suggested a comparable pathway, albeit, in the context of Alternative Investment Funds (hereinafter “AIFs”). Headed by Mr Narayan Murthy, the AIPACreleased its report on 23 July 2018. One of its key recommendations was “…allowing CSR investments in non-profit dedicated social impact AIFs.” AIPAC suggested “that CSR rules in the Companies Act permit investments by companies in Social Venture Funds of Category 1 AIFs (Schedule VII of the Companies Act, 2013) to expand the pools of capital available to non- profit social entrepreneurs, which are section 8 companies. These funds can be allowed to recycle their capital through debt funding with the proceeds at the end of their life donated to the PM’s Relief Fund or other social causes.” Although the AIPAC recommendation on usage of residuary proceeds of social impact AIFs for social causes may not appear relevant, the rationale of “recycling of capital,” is pertinent even in relation to SIBs (in the manner advocated for above). Expanding the mandate of CSR to allow corporate expenditure on SIBs with a recycling mechanism can prove lucrative to address public sector issues so identified.

4. Conclusion 

In a dynamic market wherein corporates are being sensitised of their social and governance-related obligations, the introduction of modern age financial instruments may prove a worthwhile step. Needless to say, regulatory structures must be debated upon and conceived to ensure transparency and effective governance. By monetising the available private funds and capitalising on the existing legal structures, the government can encourage private action for public ends and generate new pathways to achieve the SDGs and budgetary goals.

Disclaimer

The views and opinions expressed by the authors are personal.

About the Author 

Ms. Jyotsana Singh is a corporate lawyer at a leading law firm in India.

Editorial Team 

Managing Editor: Naman Anand 

Editors-in-Chief: Jhalak Srivastav and Akanksha Goel 

Senior Editor: Muskaan Singh 

Associate Editor: Pushpit Singh

Junior Editor: Manav Ganapathy

Preferred Method of Citation  

Jyotsana Singh, “Corporate Social Responsibility: Funding Projects Through Social Impact Bonds?” (IJPIEL, 20 April 2022) 

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