Environmental, Social and Governance (ESG) – Prevalence And Relevance

Bharti Badesra (Senior Partner)

Sustainability has an important role in financial markets. ESG or Environmental, Social and Governance is the most rapidly expanding sustainable investing method. “E” in the ESG stands for environment, which refers to the use of energy and management of environmental impact by the corporations. “S” stands for a social factor that takes into account the corporation’s interactions with employees/labour, talent, data privacy, product safety and relationship with its consumers. G stands for governance which considers the corporation’s internal system of control, policies and procedures. It basically refers to how ethical the management is in conducting its activities. These three factors are intertwined and thus cannot be read in isolation. ESG collectively plays an important role in the sustainability and ethical impact of any investment by a corporation.

There is an increasing focus on longer-term thinking, where business leaders from corporations and asset managers come together to promote long term corporate and investment management. The objective is to invest in the companies that stand to gain significantly from favourable sustainability trends.

ESG is not an entirely new concept. The social responsibilities of a corporation have been recognized and formulated earlier in terms of Corporate Social Responsibility. (CSR). Both ESG and CSR is a part of corporate governance increasingly overlap with each other in their application.

For a long time, the corporations limited their focus on short term financial gain, and thus, there existed a gap between acknowledging the importance of sustainability and acting on it. Modern economic trends have suggested that financial, as well as non-financial performance indicators collectively, are responsible for a strong business hold in the market. ESG factors are non-financial performance indicators of a corporation. They account for a significant proportion of the value of a corporation, especially for the longer term. However, traditional financial reporting tools lack the capacity to take into account and inform investors about the value of reputation, quality, brand equity etc. which are significant in a global economy. Within and across industries, there are a variety of technical solutions available for rating a corporation’s ESG scorekeeping in consideration the intangible assets. There are several indexes that can be used to measure, monitor, analyze, and report on a company’s ESG performance, for example, the Nifty 100 ESG, the Nifty 100 ESG Enhanced etc.

The growth of corporate reporting standards has increased significantly, and they have been embraced internationally by leading. There are various well-known international regulations and frameworks for mandating and reporting ESG, which have been developed through many consultation processes such as United Nations Global Compact (UNGC), Global Reporting Initiative (GRI), Integrated Reporting (IR), ISO 26000, Sustainability Accounting Standards Board (SASB) etc. India’s corporate governance reforms have also broadened its horizons. Recent additions in the Companies Act, 2013 is proof that the traditional concerns of directors, shareholders and financial stability are no more only driving factors of corporate growth and management. The Ministry of Corporate affairs issued National Guidelines on Social, Environmental and Economic Responsibilities (NVGs) in 2011 that guided businesses on responsible business conduct. It gave businesses advice on what constitutes responsible business behaviour. These NVGS have been revised to match the Sustainable Development Goals (SDG’s) and United Nations Guiding Principles on Business and Human Rights (UNGP’s).

ESG investing is becoming increasingly popular and is most likely to surpass the challenges faced by traditional investing techniques used in the past. There are multiple surveys and studies that substantiate the claim that ESG practices in corporations result in better operational performance and better stock performance of the companies. Following ESG practices have also lowered the cost of capital for many corporations. Sustainability is no more a niche area of interest for those investors who want to align their investment goals to their personal values and beliefs. It is a profitable form of investment for all the stakeholders who are looking for better risk management and long term positive growth of their business. With the change in the attitude of the consumer from consuming products that offer only material benefits to being more environmentally conscious, corporations are racing with each other to meet the new market standards.

However, there is no universal set standard for ESG reporting and thus no uniformity in measurement. Different platforms offer various technical solutions, which lead to a lot of discrepancies and the investors confused on which platform to use. As ESG reporting encompasses a broad scope that sometimes also allows corporations to do trade-offs, the corporations, on the one hand, improves one of the reported ESG metrics and, on the other hand, worsens the unreported ESF metric. Thus., improvement is required in ESG reporting with a new comprehensive system or a common framework.