What is ESG and why should investors embrace it?

Environmental, Social and Corporate Governance (ESG) is an umbrella term for a broad range of environmental, social and governance factors against which investors can assess the behaviour of the entities they are considering for investment. ESG investing particularly aims to mitigate risks and identify growth opportunities in investee companies. Unlike ethical/impact investing, ESG investing actually assesses risk-return characteristics to boost the financial performance of investee companies. The increasing popularity of ESG investing among institutional investors and retail investors alike has been driven by the recognition of ESG’s impact on investor returns, client demand for greater transparency, and evolving regulatory intervention. Investors have seen benefit both from the incorporation of ESG factors into investment screening and from actively promoting ESG compliance in existing investee companies. In fact, investors are encouraged to manage ESG risks across deal sourcing, investment decision-making, asset takeover and even at exit.

While the primary focus of ESG integration is on maximizing value creation through risk management, cost savings and long-term revenue optimization, it simultaneously improves regulatory compliance and elevates brand image. ESG-focused companies reported above-average performance during economic slowdown and noted that higher gender diversity led to better equity return. Doughty Hanson, in particular, observed that ESG-based initiatives saved them millions in accident costs, insurance premiums and waste disposal expenditure.

What is the role of lawyers in ESG implementation?

Lawyers are instrumental to ESG implementation starting from designing investment strategies, undertaking due diligence, mapping reporting compliance, facilitating dispute resolution and advising on sustainable financing. Legal advisors can design customized diligence for each transaction and ensure that third party consultants cover the higher level ESG approach in their review. The primary role of the legal team in ESG investing is to evaluate regulatory compliance, in particular with ACAB[1] laws, data-protection laws and environmental laws.

The ESG Compliance and Reporting Framework in India

While we have always had legislation in place to regulate environmental risk, corporate governance  and social responsibility of companies towards employees, suppliers and customers, an ESG-specific reporting framework is a relatively recent addition to the regulatory environment. In 2011, the Ministry of Corporate Affairs (MCA) released the National Voluntary Guidelines on the Social, Environmental, and Economic Responsibilities of Business (NVGs) which sets out nine core principles ranging from customer value and sustainable production to the promotion of human rights. In 2018, the NVGs were modified to form the National Guidelines on Responsibility Business Conduct based on the United Nations Guiding Principles on Business & Human Rights.

By 2019, SEBI required the top 1000 listed companies to annually report on NVGs. The MCA in 2020 and subsequently the SEBI in 2021 published the Business Responsibility and Sustainability Reporting (BRSR) framework. Slated for implementation from FY 2022, the BRSR framework aims to collate non-financial, sustainability information for stakeholders. Under it, the top 1000 listed entities will be required to make disclosures on the MCA21 portal from the perspective of ESG factors in order to enable businesses to engage more meaningfully with their stakeholders, and encourage the companies to go beyond regulatory financial compliance and report on their social and environmental impact. In addition to this, several international agencies and indices provide sustainability metrics, along with national indices (by NIFTY, S&P), which evaluate and rate companies on ESG-criteria based on public and independent data.

ESG in Practice

A survey undertaken by Apax Partners’ revealed that investors view ESG as beneficial for risk-management and value creation, as is evidenced by enthusiastic investor participation in KKR’s Green Portfolio Program. In India, P&G introduced 100% recyclable bottles, Ultratech and Dalmia Cement committed to a carbon-negative roadmap, Mahindra has built a $600-million green portfolio and Asian Paints is aiming to minimize operation impact on biodiversity. Havells eliminated radioactive product-parts and facilitated zero-water discharge while Godrej is eliminating landfill waste and has committed to no-waste packaging by 2025.

In essence, global investing is being increasingly steered by ESG criteria. It is time for more Indian companies to rise to the occasion and implement the sustainable and mindful business practices emphasized by ESG in order to create an improved and ESG-compliant market for investors and stakeholders.

Authors:

Ananya Sharma, Partner
Yashi Saraswat, Associate
Rhiti Chattopadhyay, Associate

Footnote:

[1] Anti-Corruption and Anti-Bribery