MC Explains | What is a 'zero-coupon, zero-principal' instrument?

What are 'zero-coupon, zero-principal' instruments?

These are financial instruments that any non-profit organisation can use to raise funds.

Usually, such organisations raise money through donations from individuals or corporates. Now, they can issue a zero-coupon, zero-principal security through a social stock exchange (SSE) and those willing to donate money to their cause can buy these securities.

Social stock exchanges, if you remember, were first cleared by Sebi in September 2021. They are meant to be exchanges–like the NSE and BSE–except they will list only securities that raise money for non-profit or for-profit social enterprises. These exchanges are still in the works.

The latest is that the capital market regulator has come up with a broad framework for them to operate under the current stock exchanges. Therefore, even this new instrument will take a while to come into the market.

Meanwhile, here is how the instrument will be structured.

With its zero-coupon, zero-principal structure, it resembles a debt security like a bond. When an entity takes a loan by issuing regular debt security like a bond, it has to make interest payments and the principal when the bond matures.

But with this new financial instrument, when an entity issues these securities and raises money, it is not a loan but a donation. So, the borrowing entity does not have to pay interest—therefore zero coupon—and it does not have to pay the principal (zero principal) either.

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Like any other debt instrument, it will come with a time duration. “These bonds will carry a tenure equal to the duration of a given project,” said Nitin Iyer, AVP Products at IIFL. It has been proposed that the issue size will need to be a minimum of Rs 1 crore and the application size a minimum of Rs 2 lakh.

There is no clarity yet on whether the security will be transferable.

But why donate in this complicated manner? 

Yes, it does seem easier to head to the nearest social enterprise that you have admiration for and write a cheque or make an online transfer. You can collect the receipt and submit it for tax deductions.

Except, this new tool gives more insight into how your donation will be used.

Gaurav Ganesh Shetty, Assistant Professor (Finance) at NMIMS Navi Mumbai, told Moneycontrol, “There have been concerns around lack of transparency in the way donations are used by these (non-profit or for-profit social) enterprises. The organisations listed on the exchange will need to do regular audits of social impact and these will be disclosed to all stakeholders (much like it is done by for-profit entities on regular stock exchanges)”.

Also, if an organisation issues these instruments and has few takers, it can be a red flag for other donors. The interested may then want to dig deeper before signing that cheque.

Iyer agrees that these listed instruments could make “the entire process (of giving donations and utilising them) more transparent and authentic”.

He also sees this move as “a government initiative to take our capital markets closer to social welfare”.

According to Shetty, the regulator may not implement the social-audit clause strictly in the beginning and give the listed entities some breathing space.

“It is hard to measure social impact like you would financial impact. These things will take time to materialise,” he said. If the security buyer or donor does not like what the social audit reveals, there is no clarity on what the redressal mechanism would be.

But the bigger change may lie in its taxation benefit, though the rules are yet to be defined.

“When you invest through this investment, you may be able to claim a 100 percent tax deduction on the donation made to the listed entity. Currently, when you donate to private entities, you can claim only a 50 percent deduction under 80G, whereas if you donate to a government-run organisation, you can claim a 100 percent deduction. There is an artificial skew that favoured government-run organisations which do similar work. With this new instrument, that may be eliminated,” he said.

Iyer said the taxation benefits are still being decided.

How can you buy the security?

Any individual or corporate can buy the security through any of the social security exchanges, once they are open for business.