India: ESG Practices: The Way Forward?

Understanding ESG in Contemporary times

Who Cares Wins was published in 2005 with the objective of integrating good environmental, social and governance ("ESG") practices into mainstream financial investing.¹ Fifteen years later, investors and executives champion ESG programs. As of late 2019, sustainable investment has crossed $30 trillion, witnessing a tenfold rise since 2004.²

More companies have become sensitive to ESG in an attempt to have favourable rankings, gain a competitive advantage, reduce operational costs, minimize regulatory interventions, and thereby boost top-line growth.³ Further, having sound ESG policies can help predict and mitigate non-financial risks. ESG has also become a crucial part of M&A transactions.⁴ In the pre-transaction phase, the process of selection of targets and partners now involves scrutiny of these factors including a thorough due diligence on ESG policies.⁵ The implementation of these policies is reflective of company culture, along with being a strong indicator of resilience. It also becomes important to assess strengths and weaknesses in order to effectively address integration issues.

Conversations on ESG have been brought back to the table amidst COVID-19, as the reliance of businesses on these factors has been highlighted.⁶ While it remains to be seen what ESG policies will look like after the effects of the pandemic settle down, it will be something that no one can ignore.⁷

While the pandemic presents an opportunity for companies to contribute to relief work,⁸ businesses are taking note of the gaps in their response mechanisms.⁹ In implementing ESG policies, companies are forced to look at potential risks they face, including pandemics.¹⁰ Companies conscious of their ESG commitments set up plans to deal with the economic impacts of coronavirus effectively. This included employee lay-offs/ retrenchments, infrastructural and technical support in modifying operations, and decision-making in the immediate future. Identifying changes in demands, supply and needs of communities has allowed companies to adapt. Due to heavy media scrutiny, post-COVID 19, consumers are likely to gravitate towards companies that adopted responsible policies and protected employees' rights. In these difficult times, investors must encourage ESG friendly investment to prevent corporations backtracking on their sustainability-friendly plans.¹¹

ESG in the Indian Landscape

ESG remains underdeveloped in India, and the rise in ESG dedication is mainly due to requirements of sustainable funds investing in India.¹² Currently, no Court in the country has delved deeply into the subject. Even though the values of some ESG issues have been recognized by the Courts (with certain subjects such as CSR, gender justice, labour welfare, and minority protection since being brought into the statute books), much of the work has been sporadic and disjointed, lacking a holistic approach.

Most environmental and labour-welfare legislation is only able to control activities to the extent of legal compliance, as opposed to ESG, which seek to establish a higher degree of care. CSR legislation is focused on philanthropic activities of corporates which is typically microcosmic. Indian corporates face unique risks, including shutting down of operations due to natural calamities, labour unrest, reputational harms of undertaking ESG-averse projects, all coupled with risks of shareholder activism and stakeholder litigation. Unfavourable moves even lead to calls of boycott on social media.¹³

While it is important to acknowledge the steps that have been taken by regulatory authorities, none of these addresses ESG directly. Some exist as guidelines, allowing businesses to self-regulate. Even the Business Responsibility Report mandated by SEBI does not cover ground on all ESG matters.

Plugging the Gaps: the Way Forward

There are various concerns with how ESG data is collected, analysed, and used that must be addressed before making it a part of financial investing. In most jurisdictions, including India, there is no provision of mandatory disclosures of ESG (albeit, as noted above, some aspects are required to be disclosed by select corporates).¹⁴ There is complete reliance on what information companies choose to share.¹⁵ The lack of standardisation of data and assessment results in the inability to compare.¹⁶ Materiality standards,¹⁷ and what is important to different investors can also have varying perspectives. Greenwashing i.e. the practice of using ESG and sustainability indices unfairly, is rampant.¹⁸ Volkswagen, despite ranking highly on the DJSI, was revealed to have manipulated technology to violate permissible carbon emission ratings.¹⁹ This exposed the fallacious nature of sustainability indices, opening up a can of worms for corporations engaging in unethical practices.²⁰

The way to integrate ESG is to bridge awareness gaps and embody global best practices. This has to be accompanied by standardised, mandatory public disclosures, inspired by the EU Disclosure Regulations,²¹ and developing assessment tools. Meaningful investor pressure must be present throughout. MCA and SEBI must step in and seek to improve data collection, its accessibility and its usability. ESG ratings/indices could be set up. The listing of green companies must be supported,²² and ESG commitment must be recognised as part of directors' fiduciary duties.

Effective legislation and regulation seems to be the way forward. Unlike traditional 'bits-and-pieces' legislation and rule making that address various elements of ESG in a very disconnected manner, there is a need for a dedicated legislation to address it holistically in order to inculcate the values of doing business in a responsible manner into corporates behaviour.

Footnotes