European consultation on social entrepreneurship funds: an analyst’s view

Taking a look at the European Securities and Markets Authority’s (ESMA) consultation.

The European Securities and Markets Authority (ESMA) recently launched a consultation to gather stakeholders’ views on the act that, once adopted by the European Commission, will allow the full implementation of the Regulation on European Social Entrepreneurship Funds (EuSEF), the nascent social fund regime.

The act, which was adopted by the Council and Parliament in April 2013, came into force in July 2013. Inputs must be sent to ESMA by December 10 and there is an open hearing on the issue taking place in Paris today (November 10).

The consultation – in accordance with the regulation – focuses on what are termed ‘level 2’ measures. These cover: 1) the types of goods and services or methods of production embodying a social objective; 2) conflicts of interest at the manager level; 3) measuring social impacts; 4) information for investors.

Point 2 doesn’t seem to raise particular concerns. ESMA’s policy option to allow EuSEF managers to establish a conflict of interests policy appropriate to their size, scale and complexity is better than the very burdensome rules on conflicts of interest that are set out in the Alternative Investment Fund Managers Directive (AIFMD) regulation.
In fact, we could argue that the obligation to disclose the identity of the manager and any other service providers, together with a description of their duties and remuneration, is already a good insurance potential conflict of interest issues.
By contrast, the other three points are likely to arouse some debate. Point 1 refers to the definition of “qualifying portfolio undertaking”, a definition that has already originated a fierce debate along every step of the EuSEF regulatory process.

In fact the first definitions put forward by the Commission recalled the definition of SME in that they were to have provided services or goods or employed a method of production of goods or services that embodied their social objective. But they should also have had an annual turnover not exceeding €50m or an annual balance sheet total not exceeding €43m, and less than 250 employees.
Furthermore, profits couldn’t be distributed. After a first round of consultations with EU stakeholders, the reference to the number of employees was cancelled (clearly, social businesses providing, for instance,long-term care services, are very labour intensive) and the non-profit distribution constraint was relaxed.

The 2011 Commission proposal though, still contained the turnover limit, which was then removed by the European Parliament. Another important change imposed by the Parliament concerns the possibility, for qualifying undertakings to be entities providing financial support exclusively to social undertakings. Coming back to ESMA’s proposed advice, the favored approach consists of a mix of general principles (e.g. “2. The primary purpose of the enterprise, irrespective of the legal form it adopts, shall be to address a social or environmental problem”) and indicative lists of examples (e.g. “6b. the enterprise produces goods or services that have a positive environmental impact like, for example, any of the following: biodiversity conservation, energy and fuel efficiency, natural resources conservation, pollution prevention and waste management, sustainable energy, sustainable land use, and water resources management”).

Indeed, while acceptable in principle, the ESMA text could have some unintended consequences.

Firstly, the focus on environmental impact appears excessive. The above-mentioned point 6B could apply to many enterprises whose social purpose is very vague at best, and particularly given that any reference to legal forms or to the need of securing the undertaking’s social mission in its articles of association has fallen.

Furthermore, businesses active in the green economy are often in a more mature growth stage compared to more traditional social enterprises and social ventures, which could lead to a disproportionate share of EuSEF being directed towards them (which would certainly compromise the regulation’s primary scope).
Similarly, point 6b (“The enterprise provides financial support solely to other qualifying portfolio undertakings. This includes, but is not limited to, the following entities: credit institutions, investment funds, special purpose vehicles, crowdfunding platforms and micro-finance institutions”) could lead to a disproportionate amount of funds being directed towards already well-established financial intermediaries – hampering the development of a more diverse social impact investing ecosystem.

Finally, “the circumstances in which profits are distributed to shareholders and owners” could do with further clarification.

As for point 3), ESMA proposes to stick with the flexible approach suggested by the GECES [Group des Experts de la Commission dans l’Entreprenariat Social] social impact measurement working group. This would allow for a quick re-adjustment of the most well-known (and wide-spread) methods for evaluating social impact such as Social Return on Investment (SROI) and Impact Reporting and Investment Standards (IRIS), without forcing EuSEF managers to opt for a determinate approach. Flexibility in setting parameters allowing for a balanced measurement of social impact achieved by organizations that can operate in very different fields is important.

But it is also true that practitioners from the third sector across Europe often complain about multiplying impact evaluation methodologies – and of the need to adapt data-collection and presentation methodology.

This can lead to fragmentation of the European social impact investing market and to further costs for social enterprises.

Furthermore, it is unclear if the procedural steps set out by ESMA will be enough to allow investors to easily compare information about different EuSEFs.

Additionally, from the point of view of potential EuSEF managers who can’t already rely on extensive previous experience in the social finance domain, the absence of a methodological level playing-field could be discouraging.
Finally, on point 4, given the importance for the development of a social investment market of helping social enterprises become investment ready, ESMA’s notasking EuSEF managers to explain the reasons behind the choice not to provide capacity building services seems somewhat contradictory. In fact, given that all the burden of putting in place a social impact measurement and reporting framework is left to EuSEF managers, and considering that the regulation asks managers to work closely with social undertakings in order to set-up the best possible impact measurement model, “increased reporting costs” do not seem to be a reasonable explanation for this.
This is all the more so considering that ESMA declined to develop a common template for the provision of the information directed to investors (which of course would have saved a considerable amount of time and money for EuSEF managers).

Not providing social undertakings with advisory, consultancy and training services means that either the enterprises are already at a very mature stage and therefore don’t need these services, or that they will have to totally rely on financial intermediaries and won’t probably be in the position to survive their start-up phase for lack of assistance other than financial.
In both cases, the regulation’s principal objective of sustaining social enterprises across Europe could be seriously compromised.

Fiorenza Lipparini is an independent Policy Adviser and Researcher and a former Policy Analyst at Intesa Sanpaolo.