Are CSR regulations relevant anymore?
By Devang Bhandari
One of the fundamental principles of public policy is that it should be devised to address market failures. Market failures are in the nature of (i) information asymmetry, (ii) market power, (iii) lack of provisioning of public goods and (iv) externalities. One of the core arguments in this paper is focused on its fourth element i.e. externalities.
Businesses, typically, do give rise to externalities but this has to be addressed via regulations and strong enforcement. However, corporate philanthropy is a personal choice. Hence, the foundation of the CSR law itself to enforce corporations to donate is weak. It’s akin to interference. Even if the original objective of the CSR law was to address negative externalities created by the businesses, the route taken has been incorrect.
In a paper released in 2019 titled, ‘Corporate Social Responsibility as Obligated Internalisation of Social Costs’, the authors look at potential ways of internalising the corporate social responsibility so that it is implicitly embedded in a company’s decision making. They discuss two common approaches (before recommending reflexive governance as a third and better option) namely, prescriptive regulation and Coasian bargaining approach.
Prescriptive regulations create distortions
With regards to prescriptive regulations, the authors highlight that this approach leads to distortions of second degree. As widely known within public policy, they also highlight that government intervention distorts incentives resulting in economic actors to change their behaviour. This is true even for CSR regulations in India. There are several cases of misconduct. We have seen cases of corporations masking their marketing gimmicks under the garb of reaching out to poor people. CSR money laundering is well documented and known.
No doubt, the initial nudge in 2014 by introduction of voluntary compliance with CSR regulation did come with some benefits. The development enterprises around corporations started to get better organized. Social incubators were set up, innovative models were experimented. Corporations that took this responsibility as seriously as their core business brought sustainable positive impact within the community. Unfortunately, this is a small percentage only. Most corporations have failed to nurture and develop social enterprises or simply avoided the entire effort by choosing to donate to government created relief funds.
Regulation along with specific directives have further created ambiguity leading to geographical bias that has led to lack of CSR funds deployment to areas and beneficiaries who needed this the most. Finally, there are issues with social enterprises as many end up engaging in unethical practices. There is a serious issue around the existence of spurious NGOs. Thus, it is not surprising that the government has started to come down heavily on NGOs especially in relation to FCRA. This, however, has resulted in pendulum swinging too far thereby significantly impacting genuine social enterprises.
Incentives for corporate social responsibilities are changing
One fear that is associated with doing away with CSR law is the significant evaporation of CSR funds thereby impacting thousands of beneficiaries and NGOs. I don’t deny the existence of such a risk but the impact may be minimal. And, if the regulations are restructured carefully, it can actually trigger higher cash flow and strengthen the ecosystem much better. I will discuss policy related recommendations in the concluding section, for now, let me highlight the changing incentives that minimizes this risk considerably. These include (not intended to be exhaustive) –
Emergence of millennial employees as key stakeholders: Even during campus recruitment, students are now asking the question on how corporations are executing their social and environmental responsibilities. Having a strong and integrated environmental and social practice is now a key element of a company's employee value proposition.
Aware consumers: Although India is lagging behind here, it's only a matter of time when the voice of the aware consumer becomes much more powerful. Global surveys have indicated that the consumers are willing to sacrifice on price if they know that the products are sustainable and the corporations involved are actively engaged in improving the lives of the community.
ESG from being a buzz word to becoming actionable: Financial investors including private equity are beginning to look at Environmental, Social and Governance diligence as a core element of target evaluation. Financing incentives to ESG focused corporations are gradually becoming visible.
Retail giving is on the rise: The success of India Covid Response Fund (ICRF) by GiveIndia, emergence of other platforms like Ketto & Milaap are clear indications of this trend.
Indian Billionaires & their charity efforts: Although there is a lot of ground to cover here but there are shifting trends of more billionaires donating part of their wealth for social causes. This is either by way of giving pledge or setting up their own foundations.
The rising Social Stock Exchange (SSE): Formation of social stock exchange is underway. Its aim is to channelize the funding to the deserved enterprises, that are able to establish the primacy of social impact, in a structured and efficient manner. This initiative brings the market and community together. SSE can play a significant role in strengthening the ecosystem
Is the time for CSR regulation up?
Although the answer cannot be a straight yes or no, it's important to re-look at the restrictive structure and go back to voluntary as opposed to a mandate with some significant changes including removal of certain clauses that indirectly led to geographical bias.
In order to avoid old product packaged with new cover, I propose following additional considerations to go in line with changes in regulations:
Integration of Social Stock Exchange (SSE) within the CSR ecosystem: It is critical that the regulations recognise social stock exchange and its potential instruments to provide a wider area for corporates to invest. SSE can actually serve as a key body and has the potential to streamline both the funding as well as the functioning and reporting of impact enterprises. The Technical Group submitted its Final Report on SSE in May 2021 which includes some relevant recommendations w.r.t NPOs (Not for Profit Organizations):
a) Registration of NPOs: In order to gain credibility and visibility, NPOs are given an opportunity to register with SSE subject to specific governance and reporting requirements and establishment of primacy of social impact. For some time now, there has been a need for a central regulatory body to govern the functioning of the NPOs, however currently such governance is spread across various institutions. Bringing NPOs to the SSE enables a single platform for governance. Hence, I would actually recommend requiring all NPOs to register with NPOs. Although this requires multiple changes across various laws and makes matters complicated. A diluted version perhaps would be to enable regulatory incentives to SSE registered NPOs, thus creating pull factors. Ultimately SSE should evolve into an overall regulatory institution for NPOs in the country.
b) Ability for NPOs to issue innovative instruments like zero coupon zero principal bonds: Such instruments focus on validated social returns. Regulation flexibility needs to be provided to recognize this and other innovative instruments (viz. impact linked debt etc.) that eventually focus on social outcomes.
Favourable Income Tax regulations: Income tax laws can be amended to recognize entire CSR spend as tax deductible and perhaps here a linkage with SSE can incentivize corporations and NPOs to support its scale-up. Currently limited types of CSR expenditures are tax deductible under various sections of the act.
NPOs Rating: There is a need to develop a NPO rating system. Combining with the framework of reporting and social audit, a rating system can go a long way in enhancing the current governance environment. The rating system can be integrated across regulations and can be mandated for all NPOs above a specific size.
Ultimately, the government can marginally change incentives to drive significant adoption and development of the entire CSR ecosystem. Restrictive rules of CSR will only lead to higher cost of doing business in India. It is a double whammy as it does not achieve the intended objective nor it eases business operations. Finally, to develop the ecosystem requires supporting innovative approaches to solving community problems along with innovative financing. Minimal regulations with marginal incentives and a strong institution will go a long way in enhancing the development sector and corporate interface.
The author is currently pursuing PGP in Public Policy from the Takshashila Institution. Views are personal and do not represent Takshashila’s policy recommendations