Investing in ESG Initiatives: The Way Ahead

In the wake of escalating global challenges like climate change, corporate misconduct, and rising social and income inequality, ESG investing has gained significant prominence among investors, stakeholders, and regulatory bodies. This article provides an in-depth coverage of the various challenges, complexities, and improvement areas associated with the ESG framework. Further, it highlights the crucial role of asset managers, investors, regulatory bodies, company managers, and society in advancing and shaping ESG investing in India.

Introduction

ESG (Environment, Social, and Governance) is a critical framework for assessing a company's ethical and sustainable practices. The ESG encompasses three key non-financial dimensions that include: impact on society, environment, and corporate governance. ESG holds utmost importance for India, as India experiences extreme weather events, rising sea levels, floods, changes in weather patterns, uneven rainfall, and landslides. Also, India continues to work towards addressing important social challenges like poverty, low-level income, and income inequality. Ethical conduct and strong governance contribute to promoting transparency and attracting investment in India.

The regulatory framework for reporting sustainable business practices in India can be dated back to 2009, when the Ministry of Corporate Affairs (MCA) launched "Voluntary Guidelines on Corporate Social Responsibility". Over the years, the reporting framework for responsible business practices has changed from voluntary guidelines to mandatory reporting. SEBI introduced the Business Responsibility Report (BRR) in August 2012, making it mandatory for the top 100 listed companies to file the BRR. The BRR intends to communicate the responsible business practices adopted by the companies to their stakeholders. In 2021, the Business Responsibility and Sustainability Report (BRSR) replaced BRR. The top 1000 companies based on market capitalization have to compulsorily include BRSR as a part of the Annual Report from the financial year 2023-24. The BRSR is indeed organized into 3 sections, the first section is related to general disclosures, the second pertains to management and process disclosures, and the third section focuses on principle-wise performance indicators. The BRSR initiative will help investors and companies alike. Investors will now be able to take informed investment decisions, as investors will be aware of opportunities and risks related to sustainability. On the other hand, companies can also attract new capital and investors by sharing their sustainability initiatives and bringing in more transparency. Furthermore, "BRSR Core" was introduced in 2023. BRSR Core is a subset of BRSR, and it discloses the ESG performance of companies across nine major Key Performance Indicators (KPIs)/metrics (SEBI, 2023). Beginning from the financial year 2024, the top 150 companies based on market capitalization are required to file BRSR Core compulsorily.

Indian companies' efforts towards sustainability are getting recognized by international agencies. 18 out of the 106 companies in the Dow Jones Sustainability Emerging Markets Index, which is a gold standard for measuring the company's efforts towards ESG parameters, are of Indian origin. The index consists of companies from 20 emerging nations and is widely referred to by analysts and investors around the globe for investment decisions. Further, according to a study by DBS Bank, Indian companies are more focused on ESG reporting and compliance as compared to the regional counterparts like China, Singapore, and Hong Kong. Additionally, India is also a signatory to "The Paris Agreement" and has pledged to reduce the emissions intensity of greenhouse gas as a percentage of GDP to 30-35% by 2030 from the 2005 level. Further, it has pledged to increase the forest cover and scale up the power capacity using non-fossil fuels to 40% in 2030 (Centre for Policy Research, 2016). Many corporate houses like Dalmia Cement, Infosys, Tata Motors, and Mahindra & Mahindra have become part of the RE100 initiative and are committed to sourcing 100% energy from renewable sources (Mudaliar and Telang, 2020).

The Reserve Bank of India (RBI) is now a member of the Network for Greening the Financial System (NGFS). The NGFS is a group of central banks and financial supervisors that share best practices and work to mitigate financial risks posed by climate change, while also mobilising capital for low-carbon and green investments. This step would help India in its transition towards a sustainable economy. Besides various regulatory measures, the Indian government has also introduced various policies, financial incentives, and tax rebates to support sustainable business practices, renewable energy, and eco-friendly business conduct.

Apart from regulatory actions and policy initiatives, the ESG adoption in Indian is also driven by domestic and foreign businesses. India is a part of the supply chain for a lot of MNCs, and they all have high standards with respect to ESG parameters. This results in Indian businesses addressing ESG issues (Davis-Peccoud as cited in Mathew, 2022).

Challenges Associated with ESG Finance

Socially Responsible Investing (SRI) refers to incorporating social and environmental aspects in investment decision-making (Searcy and Elkhawas, 2012). SRI is flourishing and picking up pace globally. However, there are still some challenges that need to be addressed. First, there is a lack of SRI-related data for emerging economies. Lack of data is an impediment to the growth of SRI and results in low inflow of funds (Bruggia, 2022). Data acts as a link between ESG investments and investors in emerging markets. It helps the domestic and foreign investors to evaluate the companies and thus, make an investment. Further, emerging nations also face challenges in extracting ESG-based information from companies, and often there are imbalances between the information available and the information required for ESG screening (Payton, 2024).

Secondly, there is a lack of standardization in SRI-related terms, definitions, strategies, standards, and ratings. Socially responsible investing, sustainable investment, ESG integration, and responsible investing are often used interchangeably, and there are regional variations in definitions. Moreover, with respect to SRI strategies, the United States and Australasia do not track data on norms-based screening. Further, Australasia includes corporate engagement within ESG integration. Furthermore, ESG ratings are provided by many providers such as Bloomberg, Refinitiv, Crisil, Sustainalytics, etc., and there is low correlation between the ratings provided by these agencies (Dimson et al., 2020; Brandon et al., 2021, and Berg et al., 2022). Each rating agency uses its own criteria and methodology for providing ESG ratings. Sometimes, a company can be rated best by one provider, but on the other hand, it can be rated worst by others.

Third, the social pillar is lagging behind. Till now, among the ESG parameters, the environment and governance parameters have received most of the attention across the globe. India has also witnessed a similar trend where investors have majorly invested in climate tech. Lack of attention for the social pillar could be due to some reasons: Firstly, there is difficulty in quantifying social impact. Secondly, data related to social parameters is complex for analysis and inclusion in the investment process (Allen et al., 2021). Thirdly, unlike environmental parameters, there is an absence of a standard and reliable metric for measuring societal impact. For instance, we have greenhouse gas emission units for measuring environmental impact. All three ESG parameters are interlinked; however, by focusing on the "S" parameter, companies can improve the well-being of employees (the most important asset), build customer loyalty, and improve reputation.

Fourth, excessive focus on SRI could result in "greenwashing" efforts by the companies. Greenwashing is when a company claims to be conscious of ESG parameters for marketing/disclosure purposes, but in reality, isn't making any efforts towards sustainability. Corporations make false or exaggerated claims about sustainability practices. Moreover, asset managers can also attach misleading names to the funds and further, can mislead on how sustainability is integrated in the investment process. Greenwashing can induce investors to prefer one fund over another. In addition to this, it can also result in biased ESG ratings by the rating agencies. To curb greenwashing, governments and regulators across the globe are taking steps such as increased regulation and scrutiny. Recently, the U.S. Securities and Exchange Commission (SEC) took action against firms like BNY Mellon and Goldman Sachs Asset Management for various ESG-related misstatements (Fernstrom, 2023). However, with increased regulation, there is always a risk of unintended consequences. One such consequence is green hushing. Companies engage in green hushing by deliberately avoiding or underreporting sustainability efforts in order to escape strict regulatory actions. Worried about legal trouble and tarnished image, companies become conservative while reporting sustainability efforts to avoid greenwashing accusations.

Role of Key Stakeholders

Investors, asset managers, company management, government, and regulators all play a pivotal role in nurturing SRI. Investors, both institutional and individual investors, can act as a catalyst and bring the necessary changes to the investee company. Firstly, investors can consciously invest in funds that meet sustainability parameters. Secondly, investors might choose to use their ownership rights to improve corporate behavior, social responsibility, and ESG performance. Investors can use various methods such as shareholder activism, proxy voting, and direct dialogue with company leadership. Thirdly, investors can drive innovation in financial products by demanding more SRI options such as ESG-themed funds, green bonds, and impact investing vehicles.

On the other hand, asset managers can disclose all the material information, like portfolio holdings, investment processes, and ESG integration methodologies, to the investors. This helps to foster transparency and enables investors to make informed decisions. Further, asset managers with investment expertise can curate more SRI-focused funds according to the diverse needs and risk preferences of investors. Asset managers can also take initiatives to educate clients and contribute towards the growth and mainstream adoption of sustainable investment practices. Moreover, the asset managers can support the policy and regulatory changes that aid sustainable investment.

The management of the company can adopt sustainable practices such as reducing carbon emissions, recycling waste, and use of renewable energy sources, etc. Further, the managers can contribute by meeting the expectations of all the stakeholders. Open communication with the important stakeholders can help to build trust and confidence in the company. The management must comprehensively review the existing policies with regard to ESG criteria and accordingly plan the roadmap for the future. In addition to this, focus on diversity, workplace safety, well-being of employees, and transparent pay policy can further enhance responsible behavior. Managers can uphold high standards for corporate governance by fostering transparency and encouraging ethical behavior.

The government undertakes a pivotal role in fostering the growth of SRI in a nation. Firstly, the government can shape the regulation that promotes transparency, standardization, and accountability in SRI. Secondly, it can oversee the proper implementation of rules and regulations and strengthen regulations related to investor protection. Thirdly, the government can develop a reporting framework that helps companies to disclose all the sustainability-relevant information in a standardized manner that is easy to compare and comprehend by the investors. Further, the government can provide financial incentives like tax breaks and subsidies to encourage the adoption of sustainability practices. Moreover, a partnership with the private sector can help to develop renewable energy solutions, develop green infrastructure, and water conservation, etc. The government can also lead by example by adopting ESG parameters in government spending.

On the other hand, regulators assume a critical role in shaping the regulatory climate, providing clarity to market participants, building investor confidence, and promoting accountability. Regulators may identify gaps and introduce new elements that strengthen SRI. Regulators also devise rules to avoid greenwashing, greenhushing, fraud, and unethical behavior. Regulators may mandate and standardize sustainability reporting from listed companies and to disclose all the material information related to sustainability indicators.

Conclusion

In this article, we focus on the road ahead in ESG Investing. SRI is quite popular and often promoted as the solution to the problems that the world is facing today. However, SRI faces some of the challenges that include a deficiency of credible data, insufficient data from emerging economies, a lack of standardization, clarity of terminology, greenwashing, green hushing, and the missing social parameter. Further, investors, regulators, government, asset managers, and the management of the company are central to the development of SRI.

References

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