ESG Framework In India – Explained, pointwise

Introduction

People are now becoming more conscious of the harm brought on by unfriendly social and environmental decisions by private (or public) corporations. The term ‘ESG’, which stands for all environmental, socioeconomic, and governance concerns, is consequently gaining traction in the business and corporate sector. ESG is about pursuing responsible and ethical business practices with attention to social and environmental equity along with economic development. ESG is fast becoming synonymous with sustainability. Investors and regulators have also increased their scrutiny in evaluating businesses that employ sustainable business practises and the ESG framework. In India’s corporate ecosystem, there have been two major developments in the context of Sustainability/ESG Framework. The first was Corporate Social Responsibility (CSR) reporting and spending being made mandatory under the Companies Act, 2013. The second is the Securities and Exchange Board of India (SEBI) making the Business Responsibility and Sustainability Report (BRSR) mandatory for the top 1,000 listed companies by market capitalisation.  This is a step forward in widespread adoption of ESG framework in corporate decision-making and business practices.

What is the meaning of ESG?

The practice of ESG investing began in the 1960s. ESG investing means investing based on not just traditional financial factors (like potential Return on Investment (RoI)) but also non-financial environmental, social and governance factors. ESG investing evolved from Socially Responsible Investing (SRI), which refrained from investing in business operations such as tobacco, guns, or goods from regions in conflict (like imports of diamonds from some African countries under military dictatorships). The term ESG was coined in 2004 by the former UN Secretary-General Kofi Annan.

ESG is a set of standards for a company’s operations that socially conscious investors use to choose potential investments. Environmental criteria consider how the operations of a company impact the environment (e.g., emissions or air/water pollution). Social measures examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.

Source: McKinsey, ‘Does ESG really matter—and why?’, August 2022.

What is the need for an ESG Reporting Framework?

First, Businesses have the power and resources to take good climate action, create a more sustainable, resilient future, and spend their money for this cause. ESG Reporting norms will create visibility to investors about such sustainable actions/practices by companies. The clarity will help the investors to channel their investments in sustainability-conscious companies.

Second, Globally, the landscape of sustainability reporting is evolving quickly as a result of the push for the Sustainable Development Goals and the growing momentum of the climate action movement. ESG is becoming more important in this situation.

Third, Consumers are now demanding high standards of sustainability and quality of employment from businesses. Regulators and policy makers are more interested in ESG because they need the corporate sector to help them solve social problems such as environmental pollution and workplace diversity. The investor community has also become much more interested in it.

How have the ESG Reporting Norms evolved in India?

ESG reporting in India started in 2009 with the Ministry of Corporate Affairs, Government of India, issuing the National Voluntary Guidelines on Corporate Social Responsibility (NVGs).

In 2012, SEBI mandated that the top 100 listed companies by market capitalisation file the Business Responsibility Report (BRR) based on NVGs along with annual reports. BRR was extended to the top 500 listed companies by market capitalisation in 2015 and to the top 1,000 listed companies in 2019.

CSR activities have been made mandatory under The Companies Act, 2013 for companies falling under the prescribed category.

Integrated Reporting (IR) was introduced by SEBI in 2017 voluntarily for the top 500 companies required to prepare BRR.

The National Guidelines on Responsible Business Conduct (NGRBC) came in 2019.

Business Responsibility and Sustainability Report (BRSR) was introduced in 2021 on a voluntary basis and made mandatory from FY2022-23.

Source: KPMG. Some Global ESG Reporting Norms include Global Reporting Initiative (GRI), Sustainability Accounting and Standards Board (SASB), Integrated Reporting (IR) among others.

What steps have been taken by the Government to promote ESG in India?

Sustainable investments in India are primarily being promoted by the Ministry of Corporate Affairs, with support from the capital market regulator SEBI. They have introduced various guidelines for corporations to implement the Principles of Responsible Investment. Government of India also formed the Impact Investors Council (IIC) to drive the impact of investments in the country.

India is witnessing innovative instruments by investors to finance social and environmental initiatives. India’s first green bond was issued by the Ghaziabad Municipal Corporation, also listed on the Bombay Stock Exchange (BSE). The Corporation raised a capital of INR 150 crore to partially fund the water treatment plant and tertiary sewage.

The Finance Minister of India, recently announced that the government will float a sovereign green bond. The proceeds will be deployed in public sector projects that reduce carbon intensity in the economy.

What are the salient features of SEBI’s BRSR Guidelines?

BRSR is a standardised reporting format that will provide a basis to compare environmental, social and governance goals across companies and sectors.

The BRSR guidelines are more elaborate and stringent than the existing BRR norms. BRSR incorporates metrics of international frameworks on par with global ESG reporting trends. It is a significant step towards bringing sustainability reporting at par with financial reporting.

Some of the key disclosures sought in the BRSR are: (a) Sustainability related goals & targets and performance against the same; (b) Environmental disclosures related to resource usage (energy and water), air pollutant emissions, greenhouse (GHG) emissions, transitioning to a circular economy, waste management practices, extended producer responsibility, biodiversity etc.; (c) Social disclosures covering the workforce, value chain, communities and consumers, that include: (i) Employees/workers: Gender and social diversity including measures for differently-abled employees and workers, turnover rates, median wages, welfare benefits, occupational health and safety, training etc.; (ii) Communities: Disclosures on Social Impact Assessments (SIA), Rehabilitation and Resettlement, Corporate Social Responsibility etc.; (iii) Consumers: Disclosures on product labelling, product recall, consumer complaints in respect of data privacy, cyber security etc.

The 9 principles of National Guidelines of Responsible Business Conduct (NGRBC) are aligned in the BRSR report.

The BRSR report serves as a single comprehensive source of information on non-financial sustainability measures to all the relevant key stakeholders of the business, i.e., shareholders, regulators, investors, and the public at large.

What are the benefits of ESG Norms?

First, ESG reporting norms (like BRSR Guidelines) are likely to play a bigger role in how companies are assessed, not only by investors but by consumers and stakeholders.

Second, the ESG frameworks are heading towards standardisation, which would reduce the scope of misrepresentation and greenwashing.

Third, Global acceptance of the ESG mandate is increasing. For instance the participation percentage for assessing the ESG performance of organisations on a global scale increased, going from 19% in 2019 to 33% in 2021, according to the DJSI (Dow Jones Sustainability Index) of the US. According to Bloomberg, it is estimated that by 2025, investments with high-performing ESG metrics will reach US$ 53 trillion. In India, the assets of ESG-based market funds (equity and debt) have risen to over INR 12,300 crore in November 2021, from INR 2,630 crore, in November 2019.

Fourth, BRSR Guidelines will bring in more transparency in ESG reporting. This will attract greater investments in socially-responsible and environmentally-sustainable companies. This will prompt coporates to adopt sustainable measures.

What are the challenges in adoption of ESG Norms?

First, there is reluctance among corporates to adopt sustainability measures as they increase costs (e.g., installation and operating costs of an effluent treatment plant that reduces efflux of harmful pollutants to rivers/water bodies). ESG measures enhance sustainability but at the same time impact financial viability, which is against interests of shareholders.

Second, there are no universally recognized ESG reporting standards. The investors and corporates have been using different frameworks like Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), Task Force on Climate Related Financial Disclosures (TCFD) etc. Lack of uniformity in standards may lead to mis-selling. This poses potential risks to investor protection, transparency and capital allocation in markets, among others.

Third, the impacts of ESG measures are difficult to quantify. While the financial performance of companies can be measured accurately by defined financial metrics (like profits after tax, return on assets/investments), such metrics are difficult to be defined for ESG measures. This make it difficult to measure comparative performance of corporates on sustainability measures.

Fourth, some critics argue that ESG Standards are against climate equity. There are concerns over the workability of universal ESG norms. Different countries have different environmental standards based on their Nationally Determined Contributions (NDCs). These NDCs depend upon the stage of development of a country. To mandate environment standards’ reporting under ESG framework that goes beyond a country’s commitments would amount to negating the efforts made for equity and climate justice.

What should be done going ahead?

First, there is a need to bring in uniformity across various reporting standards and create a standard ESG Reporting Framework. Multilateral institutions like G20 can take a lead here to undertake consultation with representation from both developing and developed countries.

Second, the corporate sector should take initiatives to develop robust internal ESG Frameworks. In this context, an expert has suggested five guiding principles.

Third, there is a need to enhance compliance of sustainability norms gradually. SEBI had made the BRSR norms voluntary for FY2021-22 and made them mandatory from FY2022-23 (top 1000 companies). The compliance norms should be gradually expanded to all listed and unlisted companies.

Fourth, there is a need to increase awareness about the ESG norms in investors. This will influence the businesses to adopt sustainability measures.

Conclusion

Robust ESG framework and responsible ESG investing are very important for an emerging economy like India as it provides an opportunity for all stakeholders to build an economy that is financially, socially and environmentally sustainable. SEBI has facilitated the achievement of the United Nations Sustainable Development Goals and the Paris Agreement on Climate Change by way of mandatorily requiring ESG reporting by Indian companies. Going forward, the norms can be extended in their scope and applicability to include the unlisted companies as well.

Syllabus: GS III, Inclusive growth and issues arising from it; GS IV, Corporate Governance.

Source: The Times of India, Economic Times, Bloomberg, Financial Express