“ESG”, a term that came into vogue in 2004, is an acronym for Environmental, Social and Governance aspects. Investment decisions are driven not just by valuations and projections, but also on the environmental and social sustainability of their business practices. Investors are consciously focusing on ESG matters – and such an approach is encouraging in our battle against climate change. Broadly speaking, environmental factors include the quantum of carbon footprint, handling of pollutants, water usage and recycling. Social factors include diversity, health and safety and employment standards, and the impact on communities. Governance commonly covers the policies that a company has, its risk and compliance frameworks, ethics and culture.
Traditionally, the idea of investing with a broader social objective was not part of the mainstream. ESG integration is becoming relevant in the current context as a result of accelerating environmental deterioration, and the social and health crisis (further highlighted the effects of the Covid-19 pandemic. A recent survey conducted by CRISIL indicates that over 80% of institutional investors and issuers intend to integrate ESG in their decision-making.
Investors are now focusingsing on responsible investing and seeking ESG compliance reports to assess and reflect upon long-term prospects of a company, which not only takes into consideration the financial performance of the company but also the ability to sustain adverse environmental and social situations. These ESG norms are requiring companies to be socially responsible and to align their value creation activities with the interests of the larger group of stakeholders, ie, the
environment and the society at large. This growing significance of ESG issues seems to be leading to a paradigm shift and is actively supported by Generation Y.
There is an increasing expectation from companies and large corporate houses to not only maximise shareholder value but to play a greater socially responsible role. For instance, for a consumer-centric company, it is important that the products offered are sustainable and do not violate basic environmental and social concerns. This is no longer limited to premium brands such as “Body Shop” but extends to mainstream high street brands who are also expected to offer fair-trade and recycled products even if the customer is required to pay a premium for such products. ESG matters are no longer limited to organic meat and vegetables in western supermarkets. Similarly, the demand for aluminum beverage cans is growing since the ability to recycle aluminum makes it preferable to single-use plastic. A recent report from McKinsey has shown that the demand for sustainable investment has been clearly surging over the past year and customers say they are willing to pay a premium to “go green”. Research shows that at least 70% of consumers surveyed on purchases in multiple industries, including automotive, building, electronics, and packaging categories, said they would pay an additional 5% for a green product if it met the same performance standards as a non- green alternative.
In India, clean energy, financial inclusion, healthcare, and education appear to be the primary focus sectors for investors for their ESG investments. Recently, blue-chip companies such as TCS, Reliance Industries, SBI and IRCTC announced roadmaps towards a reduction in greenhouse gas emissions and an increase in social initiatives. ITC has become India’s first company to commit to a target of 2035 to ensure that all its factories and hotels comply with the Water Stewardship Standard (AWS Standard), the global benchmark. Companies such as Tech Mahindra, Infosys and Wipro are a part of the Dow Jones Sustainability Index which assesses the ESG performance of globally companies. Another example is in the automotive market. While electric vehicles are not inexpensive and are bundled with logistics challenges in India (such as charging locations and battery safety and replacement costs), we are witnessing a rapid rise in registrations of electric vehicles.
There is a concerted regulatory push towards sustainability as investors have earmarked approximately USD 30 trillion worldwide towards sustainable investments. Globally, there has also been a surge in new launches of ESG-themed mutual fund schemes. Many global fund managers use ESG indices like the S&P 500 ESG Index, S&P Europe 350 ESG Index, and others to make investment decisions. There is growing evidence that corporates are now linking sustainable corporate practices with ESG scores. Whilst it is difficult to assign an ESG score to a company since many of these factors are subjective, and there is an array of differing approaches to integrating ESG, one thing is certain, ESG is no longer a “box checking” exercise. Companies with strong ESG scores have a quantifiable competitive edge over their peers.
Early-stage venture capital investors are showing a keen interest in supporting start-ups that actively facilitate ESG goals. In the pre-transaction phase, the process of selection of targets by institutional investors now involves a diligence of the company’s ESG integration. This is followed up with the investors making recommendations to these companies on implementing an ESG corrective action plan based on their due diligence findings.
Most large multinational companies in the world are now reporting their ESG profile in accordance with the globally-recognized frameworks. Investment firms like BlackRock, Vanguard and State Street have been major proponents in ESG investing. Portfolio managers are looking for companies that are “best in class” with “very strong sustainability profiles”. Recently, the CEOs of both Blackrock and State Street, two of the largest asset managers globally, pledged in their annual letters to investors and board of directors of their investee companies to focus on sustainability with their investment strategies. In fact, ESG-focused shareholder activism is another approach that is gaining traction. State Street, in its 2022 proxy letter, has mandated its portfolio companies to have at least one woman on their boards during
The 2022 proxy season and have 30% of their boards comprise women by 2023.
ESG can impact a company’s market valuation and is likely to be a critical factor to gauge IPO readiness of the company. Investor roadshows and offer documents address ESG matters separately. As investors become conscious of their responsibilities towards the environment and society as a whole, Indian companies are now feeling the pressure to disclose information of the negative impact of their actions on the environment and society. More IPO-bound companies have become sensitive to ESG in an attempt to gain a competitive advantage, reduce operational costs, minimize regulatory interventions, and thereby boost top-line growth. Such companies are now expected to prepare comprehensive reporting on sustainability / ESG aspects as part of their IPO offer documents. For instance, the board of Life Insurance Corporation reconstituted its Risk Management Committee to seek an ESG rating by including the formulation of a Risk Management Policy for identification of ESG-related risks prior to listing.
There have been reports of Reliance, Tata and Mahindra ramping up their sustainability teams. Even new-age companies like Zomato and Licious are looking to build a sustainable and responsible business and have hired Chief Sustainability Officers. As a result, companies that have traditionally treated sustainability as part of their larger CSR are now seeking experts in the domain.
India is moving steadily towards developing guidelines and regulations on ESG. For example, a listed company’s Board Report is required to make disclosures on conservation of energy, and recently SEBI also revamped the “Business Responsibility Report” to further strength of the ESG disclosure regime. To seek specific and standardized disclosures, the regulator has introduced sustainability disclosure requirements for listed companies, “Business Responsibility and Sustainability Reporting” (BRSR), which will act as a single comprehensive source of non-financial sustainability information to all business stakeholders. It is aligned with the nine principles of National
Guidelines for Responsible Business Conduct and is mandatory for the top 1,000 listed companies by market capitalisation to annually disclose ESG-related information from the current financial year (ie, FY 2022-23). In January, SEBI had further released a discussion paper to streamline companies’ ESG ratings by standardisation of symbols and scales for ESG ratings.
ESG ratings will soon become mandatory just as credit ratings for companies looking to raise capital.
The pandemic has had a profound impact on how corporates function, which has helped businesses apply a social and environmental lens to achieve financial profitability. Money alone doesn’t make the world go round!
(Uday Walia is a partner at Platinum Partners, a law firm. Sumnima Kataruka is an associate at Touchstone Partners, a law firm.)
Disclaimer: These are the personal opinions of the authors.