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India's Challenge: Getting ESG Right

India is undergoing a notable shift towards Environmental, Social and Governance (ESG) considerations as it strives for a more sustainable and responsible future. Before we look at some numbers showing India’s initiative that highlight the nation's ESG progress, let’s first understand the concept of ESG.

The Basics of ESG

ESG is a framework used to evaluate the sustainability and ethical practices of companies and investments.

ESG Rating

There are Various rating agencies and research firms like MSCI ESG Research, Sustainalytics, ISS ESG, Bloomberg ESG, Moody's ESG Solutions, S&P Global ESG etc. These agencies use a variety of factors to assess a company's ESG performance, including environmental impact, social responsibility, and corporate governance. They then assign a rating to each company, which investors can use to make investment decisions.

Here are some of the factors that ESG rating agencies consider when assessing a company's performance:

  • Environmental impact includes factors such as greenhouse gas emissions, water usage and waste management
  • Social responsibility incorporate factors such as employee relations, human rights and product safety
  • Corporate governance includes factors such as board diversity, executive compensation and shareholder rights

But there is problem with these ESG ratings. They can be subjective and they can be based on self-reported data.

ESG Rating Problems and Varying Standards

ESG rating problems arise from challenges in assessment and measurement, including lack of standardization, data quality and availability, subjectivity and limited scope. Different rating agencies use different standards due to methodological differences, varying investor preferences, competition and the evolving nature of ESG.

However, these ratings can be a valuable tool for investors who are looking to invest in companies that are committed to sustainability and ethical practices.

Why ESG Factors Are Important to Investors

ESG factors can have a direct impact on a company's financial performance.

  • Increased risk: Companies with poor ESG ratings may be considered more risky investments. This is because they are more likely to face lawsuits, regulatory fines and other negative consequences
  • Reduced access to capital: Companies with poor ESG ratings may have difficulty raising capital from investors. This is because investors increasingly demand companies disclose their ESG performance and adopt sustainable business practices
  • Damaged reputation: Companies with poor ESG ratings may suffer from a damaged reputation. This can make it difficult for them to attract customers, employees and partners
  • Lost opportunities: Companies with poor ESG ratings may miss out on opportunities to grow their business. This is because they may be excluded from government contracts, denied access to certain markets, or face other barriers to growth

Impact of ESG

Now-a days, investors actively look at companies’ intentions and actions towards ESG consideration. BlackRock, the world's largest asset manager, has emphasized the importance of ESG integration in investment decisions. Investors increasingly demand companies disclose their ESG performance and adopt sustainable business practices. Companies that do not meet these expectations may have difficulty raising capital from investors.

Greentech Startups Showing the Way to ESG

Bloom Energy, founded in 2008, is a leading player in the fuel cell industry. With solid oxide fuel cell (SOFC) technology, they provide clean and efficient electricity generation. Bloom Energy's revenue reached $785 million in 2020, driven by the scalability of their SOFCs for various applications.

OpenInvest is a fintech company specializing in sustainable and impact investing. They offer customizable portfolios aligned with investors' values, emphasizing ESG factors. In 2021, JP Morgan acquired OpenInvest, expanding its offerings to meet the rising demand for ESG-focused investments.

Companies That Paid the Price: Consequences of Flouting ESG Norms

  • In 2021, global banks like Standard Chartered and HSBC declined funding for Adani Enterprises' Carmichael coal project in Australia due to environmental concerns and carbon emissions. In 2022, the British bank Barclays refused to provide funding to the coal company Adani because of Adani's plans to build a new coal mine in Australia
  • The US EPA revealed that Volkswagen installed illegal software to manipulate emission tests, resulting in cars producing up to 40 times the permitted pollution levels, leading to a recall order for 482,000 VW and Audi vehicles produced since 2009
  • In 2021, the Dutch bank ING refused to provide funding to the oil and gas company Shell because of Shell's plans to expand its oil and gas production
  • In 2023, the French bank BNP Paribas refused to provide funding to the cement company Lafarge Holcim because of Lafarge Holcim’s poor environmental record

India’s Progress in the Realm of ESG

Environmental:

  • India ranks among the world's top countries with over 100 gigawatts of installed renewable energy capacity as of 2021 and aims to reach 450 gigawatts by 2030
  • In 2021, India emerged as a significant player in the green bond market, issuing approximately $10 billion worth of green bonds

Social:

  • Over 430 million bank accounts have been opened under the Pradhan Mantri Jan Dhan Yojana (PMJDY) since its launch in 2014, enabling financial inclusion
  • The Swachh Bharat Abhiyan (Clean India Mission) has constructed over 110 million toilets across rural India, enhancing sanitation coverage

Governance:

  • Over 12 million people have been trained under the Skill India Mission, equipping them with industry-relevant skills and improving their chances of sustainable livelihoods.
  • The Swachh Bharat Abhiyan (Clean India Mission) is a nationwide campaign that aims to eliminate open defecation and ensure access to sanitation facilities

Growth and Impact

India's progress in the ESG space is reflected in several key numbers and rankings:

  • According to the 2020 Global Sustainable Investment Review, sustainable investment assets in India accounted for approximately $2.68 trillion
  • In 2021, India's sustainable debt market reached $13 billion, up from $2 billion in 2019
  • The number of ESG-focused mutual funds in India has grown from 2 in 2019 to 15 in 2022
  • India's ranking on the Climate Change Performance Index has improved from 120th in 2019 to 105th in 2022
  • India's ranking on the World Bank's Doing Business Index has improved from 130th in 2019 to 63rd in 2022

How Are Indian ESG Funds Performing?

The state of Indian ESG funds is still in the early stages of development. However, there has been a growing interest in ESG investing in India recently. Indian ESG mutual funds have been performing well in recent years. According to a report by Morningstar, the average annualized return of ESG funds in India was 15.1% over the past three years, compared to 13.5% for the broader market.

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There are several reasons why ESG funds may be performing well:

  • ESG companies are more resilient to shocks and economic downturns than non-ESG counterparts
  • ESG-focused companies are often more innovative and can generate higher returns on equity
  • These companies are often more popular with investors. This is because investors are increasingly looking for ways to invest their money in companies that are doing good for the environment and society

Some of the top-performing Indian ESG mutual funds:

  • Quantum India ESG Equity Fund
  • SBI Magnum Equity ESG Fund
  • ICICI Prudential ESG Fund
  • Kotak ESG Opportunities Fund
  • Aditya Birla Sun Life ESG Fund

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These numbers and rankings show that India is progressing in the ESG space. India ranks 54th out of 100 countries in the 2022 MSCI ESG Ratings. These numbers reflect the Governments work towards ESG.

Expecting the Same ESG Standards From Developing Countries: Not Fair

For this, we need first to understand the position of India vs. the world, especially developed nations. India is a developing country. The Indian government has set an ambitious goal of becoming a developed country by 2047, which marks the 100th anniversary of India’s independence. To achieve this goal, the government has outlined several key initiatives, including:

  • Investing in infrastructure by the government, such as roads, railways and airports. The initiative will help improve connectivity and boost economic growth
  • The government promotes manufacturing by providing tax breaks and other incentives to businesses. This will help create jobs and boost exports
  • Investment by the government in education and training to enhance workforce skills. This will make India more competitive in the global economy
  • The government is making it easier for foreign investors to invest in India. This will help to bring in new technologies and expertise
  • Improving governance by reducing corruption and strengthening institutions. This will create a more conducive environment for businesses to operate

Developed countries grew on the back of non-renewable energy, while they now expect developing countries to use expensive renewable energy technologies that are largely available only in developed countries.

Despite the socio-economic challenges like poverty, inequality and low per-capita income, India is progressing in the ESG space. The Indian government has taken several steps to promote ESG, such as investing in renewable energy, reducing pollution and improving corporate governance.

Where Do the Indian Corporates Stand?

According to research by CRISIL, the ESG rating of 80% of Indian firms is just 'adequate' or 'below average'. Most Indian companies believe ESG rules are important, but only a few are prepared. According to Deloitte India's ESG preparedness survey, only 27% of Indian organizations feel adequately equipped to meet their ESG strategy and compliance requirements, while only 15% believe their suppliers are prepared to comply with their ESG requirements.

Why Are Indian Firms Not Getting ESG Right?

According to a survey by Deloitte on the ESG preparedness of Indian firms,

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Let’s dig into this in detail.

Complex Nature of the ESG Framework and Guidelines

  • ESG disclosures in India are governed by multiple regulations and guidelines, including the Companies Act, SEBI Regulation and voluntary guidelines by organizations like the Indian Banks' Association. This fragmented landscape poses challenges for companies in navigating and complying with diverse requirements
  • ESG requirements in India are constantly evolving, causing challenges for companies to keep up with changing disclosure regulations
  • The lack of standardized ESG reporting frameworks increases complexity, as multiple frameworks and voluntary guidelines like globally-accredited frameworks such as GRI, TCFD and IR exist alongside initiatives like the Business Responsibility and Sustainability Report (BRSR) framework, confusing companies

Considering Corporate Social Responsibility (CSR) as Part of Their ESG Acts

A common phenomenon seen among organizations is to consider Corporate Social Responsibility (CSR) as part of their ESG acts. However, ESG is a more comprehensive concept and includes, but is not limited to, CSR activities. Therefore, companies should differentiate their CSR and ESG approaches to attain social goals

Where Is the Missing Link in ESG for Companies to Adopt?

While ESG commitments stand on three pillars, the ‘S’ is typically a missing link between business strategy and regulatory compliance. Employment generation is a big challenge in India and the government is pushing hard to absorb employable youths through mega employment drives. It aims to create 1 million job opportunities with 890,000 vacancies in ministries and central departments.

Similarly, private companies should also consider recruiting apprentices and diversifying workforces as a part of their CSR initiatives. However, startups are trying to cope with the funding winter. Since the social impact is difficult to quantify, SEBI has constituted an advisory committee to enhance BRSR and develop a parallel approach for standardizing social metrics.

What Can Corporates Do to Get ESG Right?

Companies have a chance to transform ESG from a reporting activity to a catalyst for India’s growth. Here's how:

  • Consider initiatives like employment generation, diversity in the workforce and recruitment of apprentices as part of corporate social responsibility (CSR) efforts
  • Companies should differentiate between Corporate Social Responsibility (CSR) and ESG approaches to achieve social goals effectively
  • In developing economies, a collaborative effort is needed to create a reporting environment that meets local legislation while promoting transparency and reliability
  • Companies should prioritize human capital transformation, focusing on community engagement, diversity, inclusion and equity

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India's Challenge: Getting ESG Right

Ankit Abhishek
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Yatharth Chaudhary
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  • January 23, 2024
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