ESG Investments: Gaps, Challenges And Way Forward

Corporations are increasingly becoming more dominant and powerful across the world. The scale of large corporations as a proportion of world GDP is increasing rapidly. The business sector overall contributes 72 per cent of GDP in the OECD, and corporations with more than $1 billion in revenue account for an increasingly large share of that. In 2020, the top 50 firms by value increased their stock market capitalization by $4.5 trillion, bringing their total value to nearly 28% of the global GDP. Three decades ago, the equivalent figure was less than 5 per cent.

India is no different. Corporates control significant wealth in India and we see the wealth of the top corporates and their leaders growing by leaps and bounds.  One number to illustrate this is market capitalisation of listed companies in India is 104 per cent of its Nominal GDP in December 2022, compared to a percentage of 76 per cent in 2016 (CEIC Data). 

The largest corporations control a large portion of the global assets, employ a huge number of people directly and indirectly impact several more through their supply chains. They also supply goods and products and, therefore, directly or indirectly are engaged with the most of the world population.  The concentration of economic power also leads to a disproportionate ability to influence policy and society.

Typical discussions on societal and environmental issues focus primarily on what the government and civil society can do. Given their wealth, impact and influence, it is important that corporations pay attention to these issues.  The question is how to engage them on issues other than wealth or profit. This is where ESG (Environmental, Social and Governance) comes in. ESG calls on corporations to look beyond only wealth maximisation and consider ESG issues whilst managing their businesses. This is being driven by large global institutional investors, who are pushing them to consider ESG as a key factor in designing their companies’ strategies and goals. This is not being done with any altruistic motive but a realisation that corporates have to address these issues and are a significant cause of these issues. In addition, if these issues are not addressed, they can destroy markets and hence impact long-term sustainability, growth and profits.

More and more funds and investors are demanding ESG actions from corporates and the number is increasing daily.  According to a Bloomberg study, sustainable investing has now gone mainstream, with an estimated $37.8 trillion in assets under management in FY2022 and is expected to top $53 trillion by 2025

India ESG Drivers

Indian society has wide social inequities, and wealth distribution is quite skewed and the skewing is increasing. Separately, whilst India has not contributed materially to global warming, it will be impacted severely in the form of events like floods, heat waves, water shortages due to it.  Therefore, it is an imperative that the Indian corporate sector pay attention to E and S along with G. There are three other key reasons for India Inc. to adopt ESG standards

Investors:  As more and more investors embrace ESG, they are demanding that Indian companies adopt ESG standards.  Over a period, we anticipate that there will be an ESG premium and companies, which adopt ESG and are seen to adhere to its principles, will garner the ESG premium compared to their peers just like we see a Governance Premium day.  Companies, which do not meet ESG standards or are in the exclusion lists of ESG – for examples, coal, pornography and tobacco – will see fewer investors investing in their stocks and are likely to lose value.

Regulation: While regulations are getting tighter, there are also incentives for companies to adopt ESG standards.  There are incentives for green power, EVs, etc There are already regulations for extended producer responsibilities, avoidance of plastic, mandatory CSR and having adequate diversity in Boards, and tighter regulations are likely in all sectors.

Customers:  Global corporates are demanding ESG integration in their supply chains and Indian companies supplying to them will be forced to adopt these standards. In addition retail customers and employees are beginning to demand responsible conduct by corporates and prefer to buy products from companies with better ESG score.  New products are being designed with these in mind by many companies.

ESG Scenario in India

The ESG scenario in India is buzzing actively and if one sees the actions below holistically, it is clear that ESG is here to stay.

The Government of India has, as noted earlier, mandated several new regulations, and provided incentives.  The Securities and Exchange Board of India (SEBI) has introduced Business Responsibility and Sustainability Reporting guideline, which is mandatory for large listed companies and will slowly be rolled out to all other listed companies, with the following preamble: “The BRSR is a notable departure from the existing Business Responsibility Report (“BRR”) and a significant step towards bringing sustainability reporting at par with financial reporting. The BRSR is an initiative towards ensuring that investors have access to standardised disclosures on ESG parameters.”

The disclosures under BRSR are mandatory from this financial year for the top 1,000 listed companies. SEBI plans to bring out more guidelines in this area to make certain parts of the report requiring certification/ audit and has floated a discussion paper on this.

Global investors and private equity are increasingly requiring ESG integration as a precondition to investments. Bain & Co.’s Jenny Davis-Peccoud, founder and co-leader, Global Sustainability & Responsibility Practice, has recently said that over the next five years, ESG considerations are expected to influence 90 per cent of India-bound investments. That is a huge jump from five years ago when only 40 per cent of investments were taking ESG considerations into account before making investments.

Indian Mutual Funds have also started launching ESG funds. As of date there are about seven ESG funds with a total AUM of about Rs 10,000 crore.  Given the AUM of Rs 40,00,000 crore by all AUMs, this is clearly a drop in the ocean. SEBI has recently brought out a discussion paper on regulating ESG Funds and clearly expects more action in this space.  SEBI and IRDA are also mandating stewardship regulations for Mutual Funds and insurance companies. We can expect more and differentiated ESG funds, which will invest only in companies which are ESG compliant.

Rating agencies are developing indices to measure ESG and companies are advertising their ESG credentials. Last year, rating agency CRISIL launched an ESG score for Indian firms based on the knowledge available in the public domain. The scores vary from 1-100 with 100 being the best ESG performance.  SEBI is also planning regulations around ESG Ratings.

In recent years, quite a few indices have come up to track, motor and measure the ESG performance of various companies. Some of those are as follows: S&P BSE Greenex, S&P BSE Carbonex, S&P BSE 100 ESG Index, NIFTY 100 ESG Index, NIFTY 100 Enhanced ESG Index.

Several large companies have declared their intentions to become net zero by specific dates and also launching green products, floating green bonds etc.

RBI has launched regulatory initiatives on climate risk and sustainable finance while announcing key policy decisions by Monetary Policy Committee (MPC). These guidelines include; Broad Framework for Acceptance of Green Deposits; Disclosure Framework on Climate-related Financial Risks and Guidance on Climate Scenario Analysis and Stress Testing.  RBI said these guidelines will be issued in a phased manner.

We are also seeing consumers demanding ESG in companies by boycotting products sold by companies with poor track record of governance or societal issues and not addressing climate change. At the same time we are seeing companies launching products with a green label or promising to do good for the society, etc.

Challenges for ESG in India

Capital: India needs a lot of capital to address climate change and societal inequities and it needs to find sources for capital.   Indian companies must leverage green bonds, social bonds and sale of voluntary carbon to augment resources to meet the additional costs to meet E and S commitments and incentives that are provided by the government.

Data: Obtaining credible data is a huge challenge. There are also concerns of greenwashing and multiple standards. Some of these will be partially addressed by the BRSR disclosures from this year, but we need consistent standards which consider the local conditions. There are several standard setting bodies and India Inc. must participate actively in the process of setting standards.

Talent:  ESG analysis by investors and others and ESG integration within companies require a huge talent pool and it is a big challenge as it is a relatively newer field. Most companies lack qualified internal resources to implement ESG initiatives effectively. Instead, they must rely on external consultants. While this comes at a cost, it may be an effective way to outsource and comply with the need.  Several efforts to train talent are under way and they need the support of India Inc.
Way Forward

ESG is clearly something whose time has come, and it makes sense for companies to integrate ESG into their decision making not only due to pressure from investors but also in their own self-interest.  As is always the case, there will be early adopters, followers and those who use a tickbox approach.  India Inc, given its climate risks and social inequities, does not seem to have much choice but to adopt ESG.

The author is Managing Director at ECube Investment Advisors, an ESG focussed financial services company.