For Businesses, ESG Goals Will Come With A Price But It Will Be Money Well Spent

The nature of a corporation itself was questioned in the original debate, putting forth the idea ofsocial responsibility. In the same vein, a UnitedNations paper titled Who Cares, Wins under then Secretary-General Kofi Annan gave a push for ESG. The 2004-05 UN Report, which first used the acronym, recommended that analysts incorporate ESG factors in their research.

The Report highlighted the need for the buzzwords of today, sustainable development and ESG. It is an important acknowledgement that these are critical for the future of society and mankind.

What Do These Alphabets Mean?

In a paper following the European Commission adopting a sustainable finance package, Deloitte explained the key elements of ESG. The Environmental pillar is the most urgent and the most challenging. Emissions such as greenhouse gases, resources such as whether virgin or recycled materials, use of water resources, land use and deforestation and biodiversity, come under this pillar.

The Social pillar seeks to address issues relating to employee development, labour practices, health and safety standards, gender issues. The last alphabet G, Governance, seeks to address shareholder rights, board diversity, compensation issues and corporate behaviour with a focus on integrity. Obviously, not everything will apply to all companies.

Regulators the world over have put in place reporting requirements and seek to closely monitor ESG performance. They have ensured the information is put in the public domain for the investor to make an educated choice.

Getting On Board With ESG in India

ESG has evolved in India over a period of time. Topics that come under ESG issues were being addressed through various legislations: The Factories Act 1948, Environment Protection Act 1986, Air (Prevention & Control of Pollution) Act 1981, Water (Prevention & Control of Pollution) Act 1974, Hazardous Waste (Management, Handling & Transboundary Movement ) Rules 2016, Companies Act 2013, Securities & Exchange Board of India (SEBI) (LODR) Regulations 2015, Prevention of Corruption Act 1988. With no single umbrella law, the bits and pieces strewn across various laws were aimed to address various aspects of ESG.

In 2009, the Ministry of Corporate Affairs (MCA) introduced the concept of corporate social responsibility (CSR) for the first time. Though voluntary, it was meant to encourage companies to contribute to society. Companies were encouraged to put in place a CSR policy, allocate specific amounts in their budget to "bridge the gap between India and Bharat". In 2012, SEBI prescribed the Business Responsibility Report (BRR) for top 100 listed companies by market capitalisation in the backdrop of the MCA introducing the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business in 2011.

Making It Binding On Companies

BRR's focus was on capturing non-financial performance; on ethics, transparency, accountability, sustainability, promoting well-being of employees, respect and protection of the environment. The Companies Act was amended in 2015, mandating companies with a profit above a certain threshold to spend at least 2 per cent of their average net profit over the previous three years on CSR activities.

The Bombay Stock Exchange in 2018 published the Guidance Document on Environment, Social and Governance Disclosures for listed companies in India, again a voluntary requirement. The SEBI in 2021 expanded the BRR concept. New reporting requirements on ESG parameters called the Business Responsibility and Sustainability Report (BRSR) were prescribed. The BRSR sought disclosure from listed entities on their performance against nine principles of the national guidelines on responsible business conduct prescribed in 2019 by MCA.

The principles ranged from governance with integrity, functioning in a sustainable and safe manner, respect, the well-being of employees, the interests of stakeholders, human rights, environment, to businesses functioning in a responsible and transparent manner and promoting inclusive growth and equitable development. The 2021 SEBI circular was made mandatory for the top 1000 listed companies by market cap from 2022-23 showing the intent and concern of the regulator.

The BSRS requirements were closely aligned with several of the Sustainable Development Goals (SDGs). July 2023 saw SEBI issue another mandate for the top 150 companies to prepare disclosure and reasonable assurance on BRSR Core KPI (a subset of BRSR) from FY 2023-24 onwards. BRSR was extended also to the supply chain of listed companies from FY 2024-25.

SEBI also introduced a regulatory framework for ESG Rating Providers ( ERPs) from July 2023. ERPs had to register themselves with SEBI and had to follow several disclosure norms and procedures. What gets measured gets done: ERPs were mandated to offer at least six specified rating products, including core ESG rating and core transition rating.

A detailed FAQ was also issued in December 2023 for ERPs, the key development being the Chinese wall between a credit rating agency and an ERP being relaxed to permit sharing of resources. The Reserve Bank of India in recognition of the fact that the financial sector plays a critical part in mobilising resources to green activities/projects also came out with a framework for acceptance of green deposits.

Thus, slowly but surely, Indian regulators have moved towards ensuring greater ESG accountability. This has been mirrored globally as well. Be it the EU, which in 2022 passed the Corporate Social Responsibility Directive (CSRD), or the US Securities and Exchange Commission, which proposed rules to enhance and standardise climate-related disclosures, the aim has been to enforce ESG principles. Real world concerns, especially climate change, as eloquently voiced in COP 28 have driven these developments.

Winning Investors' Confidence

The challenge with ESG is to measure the impact of its mandatory requirements. Carbon emissions remain unprecedentedly high; social issues are difficult to measure and corporate governance is often opaque. In a recent issue, The Economist has advocated overhauling ESG to cut down subjectivity. The need for standardisation of matrices across ESG rating agencies is undoubtedly essential.

But this perhaps begs the question, Is ESG not critical? Admittedly, it is not a panacea for all environmental ills but it certainly does empower conscientious investors to evaluate firms on parameters other than the balance sheet; it makes greenwashing difficult.

As consulting firm Deloitte pointed out in a recent survey, ESG-driven investments have seen a spurt in India: 1 of 5 USD venture capital investments was ESG oriented. The same report indicates that companies that increase their ESG score have also seen a boost in their EBITDA. More than anything else, this demonstrates that the investor perceives ESG performance as a driver of value creation and not merely a compliance requirement.

Regulations and mandatory disclosures can be effective only when all stakeholders acknowledge and recognise the fact that what we do or not do today will impact future generations. Even if adherence to ESG requirements will add to costs, it is money well spent.

(The writer is a former chairman of the Central Board of Indirect Taxes & Customs. Views expressed are personal)