ESG Investing- The New Paradigm for India

6 mins read
by Angel One

ESG stands for Environmental, Social, and Governance-related viewpoints used to measure the ways the companies interact with all their stakeholders (and the society in general) as a part of their business processes. ESG is not just about socially responsible business but a much broader way of capturing sustainable business practices. Investors can bank on ESG analysis to identify the long-term sustainability of a business as well as any risks involved with it.

A healthy ESG practice helps an organisation to maintain good credibility or reputation. They carry lower risk probability because they incorporate sustainability as a core value. This results in steady and more long-lasting performance for the business over the years. On the contrary, organisations with a weak ESG runs the risk of instability, high-risks, and more significant potential for sudden losses over the long term. ESG accounts for one-quarter of all the professionally managed assets around the world.

For ESG investing, the environment stands for a company’s environmental disclosure, environmental impact, and any efforts to curb pollution or carbon emissions. Social refers to the workplace mindset such as diversity, human rights, and management. This also includes any relationship surrounding the community – philanthropy and corporate citizenship. On the other hand, governance accounts for shareholder rights, compensation, and the relationship between management and shareholders.

In India too, ESG investing increased manifold over the last several years, thanks to better policy reforms and awareness.

History of ESG investing

ESG investing made its inception back in the 1960s as socially responsible investing (SRIs). It was then the investors were seeking a more ethical way of doing business. They started excluding stocks or entire industries from their portfolios based on their involvement in business activities, such as tobacco production or their support of the South African apartheid regime.

Growth of ESG investing

Ethical considerations and alignment with values continue to be common motivations for most ESG investors. The field is rapidly growing and evolving. For asset owners who are responsive to climate change, solutions in the marketplace have traditionally focused on mitigation. They are trying to reduce the effects of climate change on a portfolio, by increasing exposure to green energy companies and reducing exposure to greenhouse gases. With the increasing awareness on climate change and its impact on human life and the earth, the investors now require companies to disclose how they are adapting their business strategies to accommodate the effects of climate change.

Many investors look to incorporate ESG factors into the investment process, apart from traditional financial analysis. As part of this, investment firms collect ESG data on companies and use this to make decisions on valuation and risk that a stock poses. With investors looking to ESG as a value-based measure, they are willing to measure ESG performance in the companies the same way they would any other traditional financial performance. This is leading to in-depth ESG reporting along the lines of factors such as climate change, carbon intensity, controversy exposure, and overall ESG profile.

Though at one-point ESG was a niche service for institutional clients, now it has gone mainstream. ESG now spans multiple asset classes, and it caters to a diverse group of investors. For an organisation, ESG provides an opportunity to create long-term value and foster innovation of new products, services and respond to changing customer preference.

ESG in India

The last decade has seen a stream of policy reforms that have led to the greater inclusion of ESG in Indian organisations. In the year 2007, Reserve Bank of India (RBI) issued a letter to all scheduled commercial banks, advising them on their role on Corporate Social Responsibility, sustainable development, and non-financial reporting. In the year 2008, CRISIL, Standard & Poor, KLD Research & Analytics launched the S&P ESG India Index, first investable index of companies whose business strategies and performance demonstrate a high level of commitment towards meeting ESG standards.

In 2009, the Ministry of Corporate Affairs (MCA) published Corporate Social Responsibility (CSR) guidelines. It recommended all businesses to formulate a CSR policy centred around six core elements- care for stakeholders, proper functioning, respect for workers’ rights and welfare, respect for human rights, respect for the environment, and activities for social and inclusive development. In 2010, the Department of Public Enterprises (DPE) issued CSR guidelines for Central Public Sector Enterprises (CPSEs), requiring Public Sector Enterprises to have a CSR policy approved by their respective board of directors.

In 2011, MCA published National Voluntary Guidelines (NVGs) on social, environmental, and economic responsibilities of business. The guidelines were designed to be used by all companies in India. They would then report on the nine principles in the form of Business Responsibility Report (BRR).

In 2012, the Securities and Exchange Board of India (SEBI) issued a circular that made it mandatory for the largest 100 listed companies to publish an annual business responsibility report. The requirement was extended to the 500 companies in SEBI’s Listing Obligations and Disclosure Requirements Regulations 2015. Bombay Stock Exchange (BSE) launched Greenex and Carbonex.

In the year 2013, MSCI India ESG Leaders Index was launched. In 2014, a landmark CSR law was passed to mandate companies of a particular scale and profitability to spend 2 percent of average profits of preceding years. In 2015, RBI included social infrastructure and renewable energy within the Priority Sector Lending requirements for banks.

In 2016, SEBI published its green bond guidelines, making India the second country after China to provide national-level guidelines. Indian Bank’s Association came out with the National Voluntary Guidelines for Responsible Financing to provide a systematic and standardised framework of action catering to banking sector’s risks, opportunities and responsibilities around environment, social and economic factors in an integrated manner.

In 2017, Kotak Committee on corporate governance was formed. In 2018, the Bombay Stock Exchange (BSE) published Guidance Document on ESG Disclosures, which served as a comprehensive set of voluntary ESG reporting recommendations, guided by global sustainability reporting frameworks. It underscores the importance of ESG disclosures to investors and provides 33 specific issues and metrics on which companies should focus. Nifty 100 ESG Index was launched.

In 2019, MCA further revised NVCs to National Guidelines on Responsible Business Conduct (NGRBC) to align with SDGs and the ‘Respect’ pillar of the United Nations Guiding Principles (UNGP). MCA is in the process of developing India’s National Action Plan on Business & Human Rights (in consultation with various Ministries and State Governments) by 2020. A zero draft has been released and uploaded on MCA website.

Based on all these guidelines over the years, ESG investing developed in India, leading to better corporate behaviour and transparency.

How ESG investing developed in India

Several factors led to the growth of ESG investments in India:

  • A move towards greener economy: Under the Paris agreement, in 2015, India filed its Nationally Determined Contributions, for the period 2021-2030. This states an investment of an estimated USD 2.5 trillion between 2015 and 2030. India is also committed to achieving the Sustainable Development Goals (SDGs) to carry forward its mission of development without destruction.
  • Turning it into a global plan: Factors like business ethics awareness, corporate governance, and business risks, are prompting businesses to be more pro-active. More companies now know the benefits of ESG investing. Incidentally, global ESG funds are also investing in India. According to the Global Sustainable Investment Alliance (GSIA), 41 Global E&S seeking funds have invested on an average 25 percent of their funds in India equities. In the future, there could be more ESG investing in India.
  • Gradual interest from domestic investors: Increasingly, domestic investors such as SBI, Quantum, Kotak Mahindra are taking a significant part in ESG investing. They are warming up to sustainable investments. Asset management companies are signing up to UN-supported principles for responsible investment. Over the last few years, the Indian investment market has seen the entry of quite a few ESG funds. Avendus launched India’s first ESG-based fund in 2019. Around the same time, Quantum Asset Management company launched its first open-ended ESG fund- Quantum India ESG Equity Fund. Quantum launched this to achieve long-term capital appreciation by investing in a share of companies that meet Quantum’s ESG criteria.
  • Increasing reform measures: India has been witnessing a slew of reform measures to drive investments in emerging sectors such as renewable energy, several voluntary and mandatory guidelines to drive ethical corporate behaviour, and reporting on material ESG factors.
  • Sustainability indices in India: 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.

These developments and measures have led to the growth of ESG investing in India and the world. In the US, net flows into sustainable funds reached $20.6 billion in 2019, more than four times than that in 2018. In India, the size of the Socially Responsible Investment (SRI) asset base stands at USD 28 billion, which is 0.1 percent of the global SRI assets. Domestic asset managers mainly drive this growth.

Challenges of ESG investments in India

There are specific challenges that ESG investment faces in India:

  • Lack of quality data: AccurateData about a company’s environmental, social or governance performance is usually procured from an analyst, a fund manager or an investor. There are also other sources of acquiring this data such as an organisation’s sustainability report and annual report, media, information available through public sources such as news articles. This process often tends to tedious, complicated and inaccurate. Hence, issues such as accuracy, reliability and data credibility continue to be an obstacle in expanding ESG investments in India.
  • Lack of market standards: There is a lack of market standardisation when it comes to naming ESG investing. It’s called by various names- impact investing, socially responsible investing, sustainable and responsible investing. There is also a lack of standardisation in ESG data collection, impact measurement standards and reporting methodology. This adds to another level of complexity for investors.
  • Conventional mindset: A lot of investors and asset managers consider ESG to be an added expense, which could be done away with. This lack of vision restrains the growth of ESG investing in India.
  • Lack of track record of ESG funds: Most of the ESG funds have come up recently, in the last 2-3 years. Hence, India does not have a long track record of ESG-aligned funds which does not attract as much investment.
  • Lack of advocacy: While ESG investing is gradually becoming popular with the companies, there’s still not enough advocacy about this issue, especially in India. It is essential to make investors more aware of the benefits of ESG investing.

Way forward

ESG in today’s world applies to all businesses and companies are increasingly realising its contribution. With more and more investors, shareholders, employees, clients, and regulators clamoring for greater transparency in the system, ESG investing is becoming indispensable. Especially in the new normal, ESG investing will undoubtedly play a more significant role and change the way businesses are conducted in India and across the world. This would eventually help the business community and everyone else.

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