European Commission _ Staff working paper on "The Social Business Initiative: Promoting Social Investment Funds" _ Avanzi response to consultation

1. European Commission – Staff
paper on “T he Soci al Business
Initi ati ve: Promoting Soci al
Investment Fund”
Response to consul tati on
th
Milano, September 13 , 2011
Davide Dal Maso (dalmaso@avanzi.org) and Davide Zanoni (zanoni@avanzi.org)
+39 02 305160
Summary
Who is Avanzi and why we are involved into the topic .....................................................................2
Support to social business...............................................................................................................2
Change the financial industry ..........................................................................................................3
Comments on paper ............................................................................................................................4
Defining social business ..................................................................................................................4
The funding challenge .....................................................................................................................5
The role of investment fund .............................................................................................................6
The role of investors ........................................................................................................................7
Liquidity .............................................................................................................................................8
Risk diversification ...........................................................................................................................8
Types of asset and strategies .........................................................................................................8
Asset valuation .................................................................................................................................9
Financial assessment...................................................................................................................9
Social assessment and reporting ................................................................................................9
Investor participation..................................................................................................................... 10
Risk management ......................................................................................................................... 10
Depositary...................................................................................................................................... 10
Remuneration and cost structure................................................................................................. 10
Improving transparency and clarity .............................................................................................. 11
Improving transparency through common criteria ...................................................................... 11
A common EU label? .................................................................................................................... 12
Ensuring effective integration with social businesses and distributors ..................................... 12
Use of incentives, including tax.................................................................................................... 12

2. Who is Avanzi and why we are involved into the
topic
Avanzi. Sustainability In Action is a leading and independent Think-and-do tank for
sustainable innovation. Since its founding in 1997, its mission has been to become an
independent and credible player in the field of sustainable development.
Applied research and pilot projects carried out by Avanzi have shown an innovative
approach in terms of both policy implications and actors involved. By collaborating with the
most qualified universities and research centres in Europe, it has assured an independent and
rigorous approach in both innovation drivers investigation and policies development.
Avanzi has played a pioneering role in promoting and disseminating sustainable
development and has contributed to a radical perspective change in many public and private
organisations in Italy. Avanzi has conducted research and provided innovative services and
business activities, mainly in the field of Socially Responsible Investment (SRI) and Ethical
finance, Corporate Social Responsibility (CSR) and Local Agenda 21.
Bridging academia, business and the public sector, Avanzi represents a quite unique
context in Italy: the investigation on innovative approaches, policies and instruments is
followed by their effective implementation and broad dissemination through pilot projects and
start-ups incubation with high social and environmental impact potential. By closely working
with the public, private and no profit sectors, it engages with stakeholders and challenges
reputational risks and business opportunities.
Support to social business
Avanzi assists enterprises and other organisations in acknowledging their responsibilities
towards stakeholders and in managing the change. The approach is modular and customised
and aims to integrate social, environmental and ethical concerns into all business activities
and levels, from strategy to operational management. Avanzi is also a social business
incubator. We provide a full range of business support resources and services to selected
start ups with high potential to impact social needs or challenge environmental issues. Avanzi
welcomes innovative entrepreneurs with high potential for creating social and green value and
provides comprehensive business support services, including back-office, governance
expertise, access to knowledge and financing. Avanzi applies a “stage-gate” roadmap for
incubation. First ideas and ventures based on their overall quality, degree of eco and social
innovation and consistency with market and environment conditions are selected. Then the
motivation of future entrepreneurs, their capabilities and relationship network are assessed.
Building or revising the business plan to assess financial and operational viability is the next
step in the process. Finally, the Avanzi team works closely with the entrepreneur on the key
challenges to make the start up successful. Avanzi is based in Milan, into a place designed to
inspire and realize new ideas. Located in a restored historical factory, it was once the home of
the Italian-made cult design and technology brand Brionvega, It already hosts a community of
qualified professionals and innovative start ups. The incubator is an activity carried out in
cooperation with Make a Change, an association promoting a cultural change which puts
capital and profit at the service of social good. MaC supports the development of new social
business generating benefits for everyone within the traditional capitalist marketplace and
does so using marketing levers in order to allow this new mentality to visibly spread and
assert itself.
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3. www.makeachange.it
Change the financial industry
Avanzi was the promoter, in 2001, of Forum per la Finanza Sostenibile, the Italian social
investment forum, member of Eurosif.
www.finanzasostenibile.it
Avanzi is developing a project in cooperation with a number of other organisations in Italy
aiming at the launch of a Social Stock Exchange (in Italian, Borsa Sociale), that is a capital
market dedicated to business with a social mission. With this definition, Avanzi refers to
organisations that purposefully pursue a social value.
Under Italian regulatory framework, there is a clear and rigid distinction between for profit and
non for profit entities: on the one side, companies (limited or unlimited liability) can run
commercial activities; on the other, associations or foundations (with members but without
shareholders, i.e. without a capital that can be divided into share) can do any activity except
commercial. The idea behind this scheme is that the State has the quasi-monopoly in the
domain of social affairs, addressed through the redistribution of wealth collected via taxation.
Private (non for profit) organisations can at most cooperate with the State, but act under its
vigilance or on its mandate. At the level of Constitution, the recent modification of article 118
introduced the concept of “horizontal subsidiarity”, which encourages private entities
(individuals and other organisations) to create public goods.
In order to overwhelm this distinction, we launched the proposal of a hybrid subject, named
Social Purposes Businesses (SPBs) (in Italian, Imprese a Finalità Sociale): legally speaking,
they are companies, with capital and shareholders, but their mission is not profit maximisation
but rather creation of social added value. SPBs offer a blended dividend, made up of a
[limited] economic return, plus a social-environmental return.
In Italy as well as in all industrialised countries, there is a large and growing demand of goods
and services with a high social and environmental value. This broad area ranges from health
to assistance, from education to cultural activities, from local public services to responsible
financial services, from fair trade to eco-tourism, from organic food to eco-fashion, from green
construction to renewables, with technologies linking all of them.
What distinguishes these activities is the fact that, besides the environmental and social care,
they imply some kind of relational goods – and when relationship plays a role, the nature and
the credibility of the subjects are crucial. The traditional for profit companies, although
“responsible”, suffer a lack of credibility, because people know or feel that their final goal is
profit and other conditions are constraints that they have to consider. The conflict between the
interests of shareholders and those of other stakeholders is immanent. Instead, for SPBs it’s
the other way round: stakeholders’ value is the goal, profit is the constraint that has to be
taken into account in order to assure long term continuity.
A detailed methodology to measure social value creation has been developed and will be
validated with pilot projects. Social assessment will be run at initial listing and repeated over
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4. time. A social nominated advisor or sponsor will be in charge to provide the assurance vis-à-
vis the market and the investors.
SSE is therefore an instrument to enhance these enterprises, by matching their demand of
capital with the supply of patient, responsible investors. It does not compete with existing
exchanges, because it is addressed to companies that will never list into traditional markets.
The capital supply side is represented by both institutional and retail investors. The appetite
for responsible investment is growing across Europe: more and more people feel that they
might invest part of their assets into a new asset class that, although likely to provide a
smaller financial return, can generates social benefits for the communities and, indirectly,
themselves.
SSE will be established as a multilateral trading facility (MTF), regulated by the MIFID
Directive and subject to the vigilance of the financial market Authority (Consob). The
investment company that will manage it will be backed up by a promotion company (Pro-
Borsa Sociale), whose mission is to attract both emitters and investors towards the market.
The shareholding structure and composition of Pro-Borsa Sociale will guarantee the
representation of all interested groups and a balanced governance system will be designed in
order to preserve the social mission of the initiative. Rough estimations indicates some 60-80
companies eligible for listing by the first 3-4 years.
www.borsasociale.it
Comments on paper
Please find hereby our responses:
Defining social business
Do you agree that the main features of social businesses are as outlined above?
We agree with the proposed definition, but we think that the prohibition to distribute profit can
be a limit. As long as these entities are businesses, e.g. organisations that use capitals to
produce products and services, they should play with the same fundamental rules that
“traditional” companies are subject to. We believe that social business should grow into the
market – not in a side playground. Therefore, risk capital should be rewarded. Otherwise, no
investor will ever be willing to put its money into them. Social businesses typically don’t
distribute dividends in the early stage of their development, in order to reinforce their assets
by reinvesting the margins; but there is no reason why they should continue to do so over
time, once that the financial stability is reached.
The Italian law-decree 155/2006 has created the “social enterprise”. It’s a new category that
can be added to the typical legal structure of both non-profit and for-profit companies. Without
going into the detail of this measure, it’s clear that its failure (few hundreds entities asked to
be registered as social enterprises) it’s also due to the fact that the prohibition of dividends
distribution has been perceived as a barrier by investors.
That’s the reason why we consider more appropriate a cap to ROI (return on investment)
which includes dividends and capital gain limitation. This could prevent that assets
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5. accumulation due to profit limitations translates into a capital gain when stocks are sold to the
market.
To what extent do you think this initiative should focus solely on those social businesses that
do not distribute profits to their investors? Or shall it also focus on those which distribute
profits to their investors (e.g. at least to a limited extent)? If so, how might social businesses
be distinguished from other businesses?
We think that the rationale of pure non-profit organisations is different from social business.
Social businesses are less likely to generate massive capital gains because the logic behind
their model prevents them to do so. Social business is low profit by definition, since the
process of value creation implies equal treatment of all stakeholders: if workforce and
suppliers are managed fairly, clients pay an honest price, environment and communities are
respected, one can hardly produce huge margins. Typically, high profits appear when there
are strong economies of scale (which is seldom the case for social businesses) or one or
more of the stakeholders are exploited.
But being low profitable does not necessarily mean that risk shouldn’t be rewarded. To a
certain extent, dividend should be distributed. We are not, in principle, neither favourable nor
contrary to a definite cap; we think that capping the distribution might be a good solution in
some circumstances – but the decision should be left to the partners or the shareholders on a
case by case approach.
We think that a social business should be distinguished form other business on the ground of
its outputs. No doubt that it has to clearly state into the Statute that the mission of the
organisation is the creation of social and environmental value – but this can be not enough.
The extent to which this goal is achieved has to be measured and communicated. We think
that accountability is key in this respect and we encourage the highest possible level of
transparency. In other words, the “sociality” has to be promised and, more importantly, to be
proven.
The funding challenge
What are the main difficulties social businesses face, in your experience, in getting access to
finance?
Social businesses operate in a typical area of market failure: they are not enough profitable to
attract venture capitalists and private equity investors – but they are not eligible for grants.
Social business need a specific type of capital providers, e.g. responsible investors that are
happy with a blended divided, made of a social as well as an economic return (the latter being
inevitably lower than a “normal” one).
Traditional capital suppliers are not comfortable with most social business because (i) they
operate in the area of innovation – and therefore are more risky by definition; (ii) they are
more often too small to cover the cost of assessment and due diligence; (iii) their governance
is often driven by values rather than economic interests.
Do different kinds of social businesses face different barriers?
The features that make a social business more attractive to investors are:
• Size
• Profitability
• Maturity of the market
• Credibility of the entrepreneurs
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6. To what extent do you think barriers to access to finance are limiting the growth of social
businesses across the EU?
We feel that indeed finance is the most critical aspect for a social business.
Do you agree that there is a need to tackle any such barriers at the EU level?
Yes. In particular, we think that EU can intervene to regulate the fiscal system. The paradox
that has to be handled is that social businesses are subject to the same tax regime of socially
irresponsible industries. The taxation system is focused on the legal nature of a given entity
rather than on its output. One can produce a huge amount of social benefit, but if it does so
using a limited liability company as a vehicle, it pays as it were a tobacco maker.
Even more important to promote social investment funds could be a specific tax regime for
investors and financial operators that support social ventures. If we accept the idea of tax
exemption for grants, we can imagine different levels of exemption for investments to non-
profit and social business.
The role of investment fund
If you operate a social investment fund, or are aware of the (national) legislative requirements
that apply currently in practice, could you please provide broad detail on these requirements.
No comment.
How do you think funding through investment funds might effectively compliment other
sources of funding, e.g. philanthropic funding? Are there any challenges here?
We think that investment funds can play an important role because they can minimise the
information asymmetry. The problem of social businesses is that they don’t speak the same
language of [traditional] investors; and these are not eager to invest time to know more and
eventually understand a model that is miles away from their standard. The market would need
specialised players, who know their counterparts, the context in which they operate, their logic
and their approach. In order to became a specialist, one need to reach the critical mass that
allows the investment needed for knowledge – which is in fact the case of a fund.
On the other hand, we think that funds shouldn’t be the only or preferred instrument to supply
capital to social businesses. In fact, different instruments can solve specific financial needs
along with the development stage of the company. The problem is therefore broader: a
complete chain has to be designed and supported. In other words, the market needs a sort of
“parallel” system, where specialised players do the same job of traditional investors, but with a
specific sensitivity and knowledge of a different object.
Business idea Start up Early stage Development Scale up
Seed capital Venture capital Private equity Public listing
Do you think that the UCITS framework is sufficient for funding social business without
change?
Yes, we think that UCITS framework does guarantee the basic rules to regulate also this
segment of the investment market.
Do you think a bespoke fund framework tailored to the needs of social business might be
better suited to channel funds toward social businesses?
We think that, as long as it’s proven that social businesses do produce a measurable benefit
for the community, they should be favoured through a dedicated system, for instance on tax
level. Nevertheless, specific measures might be introduced within the existing UCITS
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7. framework, especially if accompanied with a dedicated discipline for other instruments that
can complete the range of financial services needed by social businesses – without the need
to create a bespoke one.
Of course, the definition must be stated very clearly in order to prevent any abuse.
The role of investors
Do you believe that social investment funds should be open to retail investors?
We think that the role of retail investors is of the utmost importance. Social businesses are not
a different way to get the same result; they represent an innovation of the economic pattern;
they are, in fact, a cultural rather than an organisational change in the way capital can be
used. In that respect, the participation of private investors means much more that a marketing
opportunity; it’s a political act.
Besides, institutional investors are often limited in their strategic allocation by limits in terms of
weight of each asset class and are very risk adverse.
Moreover, in some European countries (for instance, Italy), where the institutional segment is
underdeveloped, the access of retail investors is in fact the only way to address significant
flows of money towards social businesses. To limit the costs for retail protections, we can
imagine different stages in the social business development and accordingly define
appropriate investment vehicles (or specific segments): at the preliminary stages, the risk is
too high for private investors, but as the business grow up, retailers may go into the market.
This principle is related to the concepts of primary and secondary market. In our Borsa
Sociale project indeed, the primary market is reserved to institutional investors, but the
secondary one is open also to private investors.
What features of a social investment fund do you think are most important for
retail/professional investors?
As stated before, the most important feature of a social investment fund, not only for private
but also for professional investors, is the accountability and transparency related to social and
environmental impacts. As the social business has to prove and measure its social output, the
fund should measure its performance not only in terms of financial return and communicates
its overall social impact. For instance, the return on investment should be transformed in
social return on investment, and the price of shares of the fund defined according to different
metrics.
What specific pre-contractual information do you think would need to be provided to retail
investors?
Since the definition of social business is very broad – or it can be interpreted in many different
ways, it is extremely important that the fund clearly states its value proposition, i.e. the type of
social value it is going to pursue. In order to avoid any ambiguity and risk of
misunderstanding, social businesses (and in consequence the funds willing to invest into
them) should clearly state which social benefit they are going to deliver and how. Pre-
contractual information should therefore be focused on indicators of social performance that
are set as objectives of the business.
Should the framework encompass funds that explicitly forego greater financial returns for the
benefit of the social risks, or both?
No comment
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8. Liquidity
What do you think would be the appropriate time frame for redemption of units in a social
investment fund, e.g. monthly?
Liquidity is a critical issue. It is difficult to balance the conflicting interests of investors and
companies. The appropriate time frame largely depends on the nature of the business and the
stage of maturity. For investment in early stage, the period should be longer and the company
should be sheltered with lock in obligations. For more consolidated business, a monthly
redemption could be acceptable.
Do you think there are other options for balancing the liquidity that small retail clients might be
seeking with a focus on a long-term time horizon?
No comment
Risk diversification
Do you think that social investment funds should be subject to diversification rules?
We think that a social investment fund should invest exclusively or predominantly in social
businesses. A mixture of different asset classes would eventually jeopardise the credibility of
the value proposition. Diversification could be achieved by investing in different types of social
businesses. At most, a portion of the asset could be invested in risk-free securities (monetary
or AAA government bonds), just to cover the liquidity risk.
To what extent do you think investors might expect a fund focused on social businesses to
only invest in social businesses?
See above.
Should social investment funds be required to invest into different types or numbers of social
business? (How many separate businesses might be required?).
No, as long as the risk profile of the product is clear to the investor.
Should there also be diversification across asset classes different from social business?
See above.
Types of asset and strategies
What types of assets should a social investment fund be able to invest in? Please give
examples.
We think that the primary need for social businesses is long term risk capital, e.g. equity.
Subordinately, debt (bonds) or quasi-equity securities.
Should the funds be limited to certain kinds of strategies (for instance, aimed at maximising
their attractiveness for retail investors)? If so, which?
No. We think that in an ideal situation, there should be as many social investment funds as
possible, competing with each other on the ground of the attractiveness of their offer – e.g.
risk profile, value proposition, cost …
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9. What rules or limits might be necessary to prevent firms using a new framework to circumvent
restrictions in other frameworks (e.g. UCITS)?
We think that the only way to prevent abuses is the robustness of the definition of social
business and, even more important, the disclosure standard for continual reporting of the
social results – along with the financial result.
Asset valuation
Financial assessment
Do you agree that it would be impractical for social investment funds to have frequent
valuations of assets? Please give reasons for your answer.
The delivery of economic value is not the primary objective of social businesses; in
consequence, social investment funds (and their clients) shouldn’t be obsessed by financial
return. In other words, financial performance and other financial indicators shouldn’t be
considered the most important pieces of information addressed to the clients. At the same
time, social investors have a long-term perspective and they are probably not so interested in
a daily or weekly valuation of their assets.
If so, for the purposes of investor protection what frequency might be appropriate?
We believe that a monthly or quarterly evaluation of asset could be acceptable to a socially
responsible investor.
Do you think that any non-social business assets that might be permitted should be subject to
different valuation requirements? Might different kinds of assets require different approaches?
As stated above, we dislike the mixture of different assets in a social investment fund portfolio
– with the exception of “socially neutral” securities, whose evaluation should follow traditional
requirements.
Social assessment and reporting
How do you think 'social returns' might be best addressed and measured?
Avanzi, within the Borsa Social feasibility project, has developed its own methodology for the
measurement of social return. This is a very complex issue, that can hardly be simplified.
However, key points are:
• Outputs are more important than statement of principles
• The crucial aspect is the consistency between mission and results
• [social and environmental] indicators are sector-related
How might this build on other existing work, for instance on non-financial company reporting,
social accounting, socially responsible investing, etc.?
There might be some similarities and ESG accounting systems do contain elements of value
but social businesses are different in essence from for profit, although “responsible”
businesses. Therefore, the assessment methodologies should be tailored on their own
characteristics.
What information do you think needs to be disclosed to investors, and how might this best be
presented?
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10. There might be different sets of indicators to be disclosed and the frequency of their
publication might differ according to their relevance. We think that some key figures should be
disclosed almost on real time; other could be communicated on a half-yearly or yearly basis.
Investor participation
Do you agree that investor participation will contribute to the success of these funds?
The evaluation of a social business, from both a social and economic point of view, is an
extremely difficult job. We think that the added value of a vehicle such as a fund is the
professional contribute that a competent fund manager can provide. Direct participation of the
investors might be justified only in case it is a specialised one (for instance, a foundation).
Otherwise, we see the risk that a non professional investor might be influenced by external
factors and creates expectancies doomed to be frustrated.
A specific exception should be regarded for investment in “local” social business, where the
link between the activity of the business and the community in which it operates represent a
value for the investor who live in that territory.
If so, please outline how this might work in practice, and whether this can or should be
required as part of the social investment fund framework itself.
Risk management
Which particular features of social investments might require specific risk management
requirements?
Whereas social business might run additional risk of failure due to the type of activity, on the
other hand the non-speculative approach should limit the exposure to default risk. We don’t
know to what extent these two features compensate each other, but we feel that social
investment fund should adopt a risk mitigation strategy based on the specific nature of the
business they invest in.
Depositary
What should be the duties of a depositary (e.g. tracking the funds' assets, reconciling units or
shares issued with subscription proceeds received)? Please give reasons for your answer.
We don’t think that the depositary should be charged of any additional duty.
Remuneration and cost structure
How might the sustainability and profitability of a social investment fund regime be ensured?
The profitability of a fund is based on a vast range of factors and it’s the ability of the fund
manager to find the right balance between the different interests. In principle, we think that the
size of the fund is important in order to dilute the fixed costs, that might be higher than those
of a traditional fund.
Are there any particular factors in your experience that might determine the commercial
success of the fund?
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11. We don’t have a practical experience, but we think that the clarity of the value proposition
statement is key to intercept investors’ objectives and assure the alignment between their
expectancies and results.
In your view, what kinds of incentive structures might be appropriate or inappropriate for the
managers of the funds (e.g. performance fees versus flat management fees)?
Price is a competitive factor. We would leave this to the market competition and we would
recommend not to intervene with any regulation.
Improving transparency and clarity
What steps do you think should be taken to improve transparency for investors in relation to
funds targeting social businesses?
We suggest the issue of guidelines setting standards for disclosure. They might be proposed
on voluntary basis in a first phase and become mandatory once “digested” by the marked and
amended by the practice.
What steps do you think should be taken to improve transparency for fund managers about
the social businesses which they target?
We don’t see the need to oblige social business to disclose a given set of information. It’s in
their interest to guarantee the highest possible level of transparency towards investors. The
most transparent will be considered more attractive (other things being equal). Having said
that, we believe that in the mid term businesses will naturally converge to a common
standard.
Improving transparency through common criteria
How do you think common criteria for defining, labelling and rating social funds and social
businesses might be most effectively established?
We believe that a bottom-up, multi-stakeholder approach might guarantee the highest level of
involvement, variety of sensitiveness and ideas. We recommend to consider the specificity of
each national market and not to exclude the possibility of different systems in different
countries – within a common framework.
Who should establish them and develop them over time?
We see room for a regulatory intervention only to set the basic, fundamental norms of the
game. Other, more detailed, rules can be decided by the professionals and the practitioners
on a self-regulatory basis. The decision making process of formal legal norms can be too rigid
and complicated for a sector that evolves very rapidly.
How might they be verified, to ensure they are appropriately used in practice?
We think that, as long as transparency is real, market forces will naturally be able to reward
the honest players and punish the free riders. Traditional system of verification (third party
assurance) can work properly for this purpose.
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12. A common EU label?
Do you think a strong new EU label (e.g. supported by a common logo) would help social
investment funds succeed?
We believe that a complicated EU regulated system would eventually weight down the
industry, that is small and fragile. We think that the best contribution EU can provide is a
strong investment in a communication campaign to make the concept of social business
better known.
How might the appropriate use of such a brand be ensured in practice, and potential for
confusion with other brands or labels diminished?
There are too many labels in the market and the risk of confusion is virtually inevitable. We
strongly doubt of their effectiveness.
Ensuring effective integration with social businesses
and distributors
What steps do you think might be taken at the European level to facilitate better
intermediation between funds and social businesses? Are there particular responsibilities that
you think fund managers should take on?
We think that social investment should be encouraged and supported with framework
measures, but market forces should be left free to find the best possible integration.
Do you think there are any possible actions at the European level that might ensure effective
distribution of social investment funds?
Nothing besides transparency.
Use of incentives, including tax
How might tax incentives be made useful? Please provide data on any existing such
incentives you are aware of.
We think that tax [dis]incentives can be powerful measure to encourage [or discourage] some
activities. Although widely used, they are in fact mechanism that can distort the free market
competition. As we believe that social businesses should compete fairly with other models in
the market and not in a separate ground. Therefore, tax incentives should be granted only for
a limited period of time, say 3 up to 5 years, with the objective to allow the growth of a new
practice. After that, a phasing out period should lead to a complete alignment.
Are there any other measures you think might be possible to maximise investor's access to
social investment funds, or the attractiveness of these for investors?
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