An Introduction to ESG

Context:

Part 1

  • ESG stands for Environmental, Social, and Governance, representing a framework for sustainable business practices.

  • The framework encompasses a wide range of elements, including environmental impact, social responsibility, and corporate governance standards.

  • ESG principles guide companies to long-term sustainability and positive societal impact.

Part 2

  • ESG considerations are essential in today's business environment.

  • Companies are expected to address environmental impact, social inequities and adopt ethical practices.

  • An ESG framework guides businesses in this regard.

Part 3

  • Investors are increasingly integrating ESG into their investment thesis.

  • The Government as well as Stock Exchanges will increasingly require reporting on ESG measures.

  • Customers are increasingly insisting that suppliers of goods and services adopt and deliver to ESG principles.

  • ESG practices result in systematic risk mitigation.

  • Companies that focus on ESG often achieve greater operational efficiency, reducing costs associated with resource consumption and waste generation.

  • Companies that prioritise sustainability and responsible business practices are often better positioned to create long-term value for shareholders.

  • ESG practices enhance brand reputation.

  • Investment in an ESG program pays rich dividends in terms of reduced risks, quality partners and higher valuations.

Evolution of ESG:

  • The core concept of ESG investing has existed for centuries, dating back to religious codes banning investments in slave labour

  • Much of the ESG landscape today was shaped by many key events, trends, actions and milestones over the past 35 years:

  • The ESG landscape continues to evolve rapidly and will expand to cover diverse areas like waste, circular economy, biodiversity, and diversity and inclusion

  • Implications for businesses:

    • Enterprises need to manage more granular and complex regulatory reporting

    • CIOs need to invest in automating and industrializing ESG data and metrics reporting to cope with the growing number of disclosure norms

    • Improvement in speed, efficiency, and data interoperability is crucial

    • Proper governance and controls for data are essential to provide verification and independent assurance

Evolution of ESG in India:

  • ESG considerations have gained momentum in India over the past decade, spurred by global trends and domestic factors

  • ⁠The regulatory framework relating to ESG is not found in any one piece of legislation but comes under various pieces of legislation, including: the Factories Act, 1948; Environment Protection Act, 1986; Air (Prevention and Control of Pollution) Act, 1981; etc. A more comprehensive list is given in Annexure 6.

  • ⁠ESG investing is gaining traction among Indian investors, driven by growing awareness of sustainability issues, the evolving regulatory landscape, and the recognition of the financial materiality of ESG factors

  • ⁠⁠Looking ahead, ESG is expected to play an increasingly significant role in India's corporate and investment landscape, as stakeholders recognise its potential to drive long-term value creation and societal impact

Stage Milestones Outcome Benefits/Impact Duration
1.Orientation • Development of ESG Landscape
• Orientation Workshop for Senior Management
• Drafting of ESG Policies
• Contextualising Key Drivers
• Defining ESG Policies
• Understanding Materiality
Benefits to the Company:
• Appreciation of the impact of ESG the business:
      • Meaning of sustainability
      • Stakeholder expectations & concerns
      • Risks
      • Potential external benefits from improved sustainability performance
•Allows ESG to inform management decisions
1-2 Months
2. ESG Data Management • Wireframing the ESG Data Management System
• Installation of ESG Data Collection Tools (Excel or web-based)
• Training of staff for data collection
• Processing of data to understand & define baseline
• Data Collection & Baseline Calculations
• Progress dashboard for monitoring & reporting
Benefits to the Company:
•Identification of carbon footprint, waste & emissions
•Measurement of sustainability initiatives & identification of impacts

Impact on Customers, Investors & Other Stakeholders: • Quantify & convey sustainability initiatives to stakeholders
• Demonstrated commitment to sustainability
• Enhanced relationships, increased trust, better alignment
3-4 Months
3. Setting Targets and Roadmaps • Consultations with senior management to set targets
• Consultation with the ESG management team to develop an Action Plan
• Target setting
• Roadmaps & Action Plans
• Internal Process Planning & Resource Allocation
Benefits to the Company:
• Established guidelines for social responsibility
• Defined governance practices
Impact on Customers, Investors & Other Stakeholders:
• Demonstrated commitment to sustainability
• Attract socially responsible investors & customers
1-2 Months
4. Implementing Actions • Implementation of Internal Measures as identified in the Action Plan (e.g. Energy Audit, Resource Efficiency Audit etc.)
• Implementation of External Measures: (e.g. buy renewable energy, recycling waste)
• Partnerships with consultants, or implementation agencies
• Implementation of initiatives
• External Partnerships
Benefits to the Company:
• Energy and resource cost savings; Higher Profitability
• Reduced environmental impact

Impact on Customers, Investors & Other Stakeholders: • Improved competitiveness
• Positive environmental contribution
• Enhanced brand reputation
• Increased customer loyalty, brand value and community support
Depends on the Action Plan. Can range from 2 -12 Months
5. Accessing the Market • Prepare the report/ESG disclosure in format selected in the ESG Landscape
• Reach out to stakeholders identified during ESG landscape to gain access to financial benefits
• Publishing ESG Disclosure
• Identifying impact creation
• Accessing the ESG-linked finances and benefits
Benefits to the Company:
• Sustained long-term business resilience, growth
• Gain external recognition for commitment to ESG standards
• Meet disclosure expectations; Trust of Stakeholders
• Increased attractiveness to investors, customers, partners
• Improved investor relations, access to capital, enhanced brand credibility
• Access to sustainable finance options
1-2 Months

Our ESG Implementation Partner:

Environment Management Centre is a strategic management consulting company established by Dr. Prasad Modak in 1996 in Mumbai. Over the last 27 years, EMC has positioned itself as a niche player in environmental management consulting across the globe.

EMC’s consultancy services are strategic, knowledge-driven and supported through research and training. In all the consulting assignments, EMC’s expertise lies in harmonizing economic, environmental, and social considerations in business development plans and policy frameworks.

Website: https://www.emcentre.com

Annexure 1: ESG Risks:

Environmental Risks

  • Increasing operating costs due to higher pricing GHG emissions

  • Write-offs and early retirement of assets due to enhanced emissions reporting obligations

  • Substitution of products with lower emissions options

  • Reduced demand for goods and services due to changes in customer preferences

  • Costs associated with adapting or deploying new practices and processes for lower emissions technology

Social Risks

  • Impact on company profitability and reputation due to labour disputes or strikes

  • Reduced demand or litigation due to safety risks in products or services

  • Disruption of operations or supply chain due to geopolitical conflicts

  • Shrinking market for products due to demographic or consumer changes

Governance Risks

  • Multiple directorships leading to conflicts of interest

  • Lack of experienced board members navigating energy transition

  • Excessive executive remuneration eroding trust

  • Scandals due to lax compliance on information disclosure, auditing, accounting, or regulations

Managing ESG Risks

  • ESG risks are often not included in mandatory financial reporting but can have significant consequences

  • Companies can benefit by managing ESG issues effectively:

    • Environmental: Reduce operating costs through renewable energy and water conservation

    • Social: Manage labour relations and supply chain exposure to avoid disruptions

    • Governance: Establish structures fostering trust and collaboration with stakeholders

Annexure 2: ESG and the Cost of Capital:

Key Excerpts from the 4-year Study by MSCI

  • Companies with high ESG scores, on average, experience lower costs of capital compared to companies with poor ESG scores in both developed and emerging markets. The cost of equity and debt followed the same relationship.

  • Companies with lower ESG scores exhibited a stronger relationship to the cost of capital than did those with higher scores.

  • In developed markets, companies with lower ESG scores, upon improving their MSCI ESG Rating, experienced reduced costs of capital.

ESG scores related to the Companies’ Cost of Capital

Relation between ESG scores and cost of capital differed within developed regions

Difference in cost of capital (in %) between high and low-scoring (Q1 minus Q5) companies by Global Industry Classification Standard (GICS) sector

   
GICS Sectors   
   
MSCI World   
   
MSCI Emerging Markets   
   
Energy   
   
0.38   
   
0.59   
   
Materials   
   
0.23   
   
0.9   
   
Industrials   
   
0.39   
   
1.03   
   
Consumer discretionary   
   
0.43   
   
1   
   
Consumer staples   
   
0.39   
   
0.69   
   
Health care   
   
0.35   
   
0.61   
   
Financials   
   
0.39   
   
1.06   
   
Information technology   
   
0.46   
   
1.14   
   
Telecommunication services   
   
0.41   
   
0.75   
   
Utilities   
   
0.55   
   
0.73   
   
Real estate   
   
0.43   
   
0.46    

Annexure 3: Evolution of ESG

1990: Domini 400 Social Index: Amy Domini, managing KLD Research and Analytics, introduced the Domini 400 Social Index, prioritizing companies with social and environmental responsibility. Initially risky, it later showed competitive returns, evolving into the MSCI KLD 400 Social Index

1992: United Nations Framework Convention on Climate Change: The treaty signed by 154 nations at the Earth Summit laid the groundwork for global climate action, including the annual Conference of the Parties (COP)

1995: First sustainable investment inventory in the U.S.: The Social Investment Forum Foundation's inventory revealed $639 billion in sustainable assets in the U.S., growing to $35.3 trillion globally by 2020

1997: Kyoto Protocol: set greenhouse gas reduction targets for 192 countries, though key emitters like China and the U.S. didn't ratify

1997: Global Reporting Initiative: Launched to address environmental concerns, the GRI expanded to cover social and governance issues, setting global standards for sustainability reporting

2000: United Nations Global Compact: Established principles across human rights, labor, environment, and anti-corruption, with over 13,000 participants in 170 countries by 2022.

2000: Carbon Disclosure Project: Founded to push companies to report climate performance, it expanded to water security and deforestation, representing investors with $136 trillion by 2023

2004: First "Who Cares Wins" report published with the term ESG: popularized ESG, advocating for its integration into investment decisions to stabilize markets

2005: Freshfields report: Proposed integrating environmental and social considerations into investor decision-making, evolving into investing for sustainability impact (IFSI)

2006: Principles for Responsible Investment: Published six principles urging institutional investors to consider ESG issues in decisions and report progress

2007: Climate Disclosure Standards Board: Established reporting frameworks for climate change, water security, and forest risks, aiming to harmonize greenhouse gas emissions reporting

2011: Sustainability Accounting Standards Board: Created industry-specific accounting standards reflecting ESG impacts on companies' bottom lines.

2015: U.N. Sustainable Development Goals: Formulated 17 goals with specific targets and indicators, covering various sustainability issues

2015: Taskforce on Climate-related Financial Disclosures: Launched to develop standards for reporting climate-related disclosures, gaining support from over 3,800 companies.

2016: Workforce Disclosure Initiative: Launched to improve data quality on workforce metrics, supported by 68 institutional investors with over $10 trillion in assets.

2017: The Compact for Responsive and Responsible Leadership: CEOs committed to aligning corporate goals with the U.N.'s SDGs, promoting long-term societal benefit.

2017: State Street Global Advisors and board diversity issues: State Street urged companies to diversify boards, resulting in increased gender diversity in many firms.

2019: Davos Manifesto 2020: Outlined ethical principles for companies, emphasizing human rights, fair taxes, and ESG objectives.

2020: COVID-19 pandemic and other events: The pandemic highlighted high-impact risks like climate change, fostering global awareness.

2020: Standardized stakeholder capitalism metrics: WEF and Big Four firms standardized ESG metrics, aiding companies in reporting progress toward SDGs.

2021: E.U.'s Sustainable Finance Disclosure Regulation: Imposed requirements for sustainable investment disclosures in the EU, emphasizing environmental and social impacts.

2022: Tesla ejected from S&P Sustainability Index: Tesla was removed due to declining ESG criteria scores, facing criticism for racial discrimination and safety issues.

2022: Consolidation of sustainability standards: The IFRS and VRF merged to form the International Sustainability Standards Board, establishing global sustainability reporting standards.

2023: EU's Corporate Sustainability Reporting Directive: EU companies must report sustainability data aligning with an EU ESG taxonomy and audit sustainability practices.

2023: ESG investing becomes a political issue in the U.S.: Congress debated the role of ESG metrics in investment decisions, highlighting ideological divides over climate-focused investing.

Annexure 4: Sustainability Reporting Frameworks

  • The Global Reporting Initiative (GRI) is an international, non-profit organization working in the public interest towards a sustainable global economy where organizations manage their economic, environmental, social, and governance performance and impacts responsibly. Corporate and public sector reporters in over 90 countries use the GRI Guidelines. More than 24,000 reports have been registered in GRI’s Sustainability Disclosure Database. https://www.globalreporting.org/Pages/default.aspx

  • The International Integrated Reporting Council (IIRC) is a group of international leaders with a mission to create the “Integrated Reporting Framework”. The Framework provides material information about an organization’s strategy, governance, performance and prospects in a concise and comparable format, a fundamental shift in corporate reporting. http://integratedreporting.org/

  • The Sustainability Accounting Standards Board (SASB) is a UN non-profit U.S.-based organization on a mission to create and disseminate accounting standards that reporting issuers can use to disclose material sustainability factors in filings with the Securities and Exchange Commission. http://www.sasb.org/

  • CDP (formerly the Carbon Disclosure Project) is a global non-profit organization, founded in 2000 with headquarters in London. CDP requests standardized climate change, water and forest information from some of the world’s largest listed companies through annual questionnaires sent on behalf of institutional investors that endorse them as ‘CDP signatories’. https://www.cdp.net/en

  • The United Nations Global Compact (UNGC) is a strategic policy initiative for businesses that are committed to aligning their operations and strategies with ten universally accepted principles in the areas of human rights, labour, environment and anti-corruption. It comprises more than 13,000 organizations in 80 local networks worldwide. Business participants are expected to publicly report on their progress in an annual Communication on Progress. https://www.unglobalcompact.org

Annexure 5: Key ESG Performance Indicators & Measurements

Environmental

   
Key ESG Indicators   
   
Measurement, Annual , unless otherwise indicates   
   
Environmental   Policy    
   
Does the company publish and follow an environmental policy? Yes/No   
   
Environmental   Impacts    
   
Any legal or regulatory responsibility for an environmental impact?.   Yes/No If yes, explain   
   
Energy   Consumption    
   
Total amount of energy usage   
   
Energy   Intensity    
   
Amount   of energy used   
   
Carbon/GHG   Emissions    
   
Total amount of Carbon and Green House Gas emissions in metric tons   
   
Primary   Energy Source    
   
Specify the primary source of energy used by the company   
   
Renewable   Energy Intensity    
   
Specify the percentage of energy used that is generated from   renewable sources   
   
Water   management    
   
Total amount of water consumption, and details in respect of   recycling if any   
   
Waste   Management    
   
Total amount of waste generated, recycled or reclaimed, by type and   weight   

Social

   
Key ESG Indicators   
   
Measurement, Annual , unless otherwise indicates   
   
Full time employees    
   
Number of full time employees   
   
Monetary and non- monetary   benefits for employees   
   
Total amount of employee wages   and benefits   
   
Attrition Rate    
   
Percentage of employee turnover   
   
Training and development hours    
   
Total number of hours of training   for employees divided by the number of employees   
   
Health care benefits    
   
Does the company publish and   follow a policy for occupational and global health issues? Yes/No   
   
Human Rights Policy    
   
Disclosure and adherence to a   Human Rights Policy   
   
Human Rights Violations    
   
Number of grievances about human   rights issues filed, addressed and resolved   
   
Child & Forced Labour    
   
Does the company prohibit the use   of child or forced labour throughout the Supply chain? Yes/No   
   
Gender parity ratio at workforce    
   
Percentage of women in the   workforce   
   
Community and social work    
   
Number of hours spent, and/or   other community investments made as a percentage of pretax profit   
   
Local Procurement    
   
Percentage of total procurement   from local suppliers   

Governance

   
Key ESG Indicators   
   
Measurement, Annual , unless otherwise indicates   
   
Gender diversity on Board    
   
Percentage   of Board seats taken by women   
   
Board - Independence    
   
Percentage   of Board seats taken by independent directors   
   
Board - Separation of Powers    
   
Specify   whether the CEO is allowed to sit on the Board, act as the Chairman, or lead   committees   
   
Voting Results    
   
Disclosure   of the voting results of the latest AGM   
   
Gender Pay Ratio    
   
Ratio   of median male salary to median female salary   
   
Incentivized Pay    
   
Specify   the links between (executive) remuneration and performance targets   
   
Business   Ethics and Code of Conduct    
   
Does   the company publish and follow an Ethics Code of Conduct? Yes/No   
   
Supplier Code of Conduct    
   
Does   the company publish and follow a Supplier Code of Conduct? Yes/No   
   
Bribery/Anti-Corruption Code    
   
Does   the company publish and follow a Bribery/Anti-Corruption Code? Yes/No   
   
Corporate Governance    
   
Percentage   of Board seats taken by women   

ESF Reporting Generally

   
Key ESG Indicators   
   
Measurement, Annual , unless otherwise indicates   
   
Sustainable Reporting Frameworks   

Does the company publish a GRI, CDP, SASB, IIRC or UNGC report? Yes/No
   
External Assurance   

Are the company’s ESG disclosures assured by an independent third party? Yes/No
   
BRR as per SEBI framework   
   
Yes/No. Voluntary / Mandatory   

Annexure 6: Main substantive ESG-related regulations in India

  • The regulatory framework related to environmental, social and governance (ESG) is not found in any one piece of legislation but comes under various pieces of legislation, including:

    • The Factories Act, 1948

    • Environment Protection Act, 1986

    • Air (Prevention and Control of Pollution) Act, 1981

    • Water (Prevention and Control of Pollution) Act, 1974

    • Hazardous Waste (Management,

    • Handling and Transboundary Movement) Rules, 2016

    • Companies Act, 2013 (Companies Act)

    • Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations)

    • Prevention of Money Laundering Act, 2002

    • Prevention of Corruption Act, 1988

    • Laws with respect to the payment of minimum wage, bonus, gratuity, welfare activities, health and safety, etc.

  • Various aspects of ESG are covered under these pieces of legislations in a fragmented manner.  For instance:

    • Section 134(3)(m) of the Companies Act requires the board’s report to contain details on the conservation of energy

    • Section 166 of the Companies Act casts duty on a director of a company to act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment

    • Section 135 of the Companies Act read with the Companies (CSR Policy) Rules, 2014 makes it mandatory for companies with a specified net worth, turnover or net profit to constitute a CSR committee to oversee the CSR policy and activities.  Eligible companies are required to annually spend at least 2% of their average net profits of the last three financial years on CSR.  The board’s report discloses CSR-related details.

    • Regulation 17(1)(b) of the Listing Regulations stipulates that one-third of the board of a listed entity must be composed of independent directors if the chairperson is a non-executive director, and not a promoter or related to a promoter, or a person occupying a management position; otherwise, at least half of the board should be composed of independent directors.

    • Section 149 of the Companies Act requires certain classes of companies to have a female director.  Additionally, Regulation 17(1)(a) of the Listing Regulations requires the top 1,000 listed entities (based on market capitalisation) to have an independent, female director on their boards.

Related Reading:

  1. ESG and the cost of capital. https://www.msci.com/www/blog-posts/esg-and-the-cost-of-capital/01726513589

  2. Why ESG strategies are fast becoming a mainstay in corporate financial planning. https://ieefa.org/resources/india-why-esg-strategies-are-fast-becoming-mainstay-corporate-financial-planning

  3. From Tradition to Transformation: ESG Initiatives in Indian Corporate Landscape https://www.icsi.edu/media/webmodules/CSJ/October/12.pdf

  4. The rise of ESG investing and sustainability reporting. https://ieefa.org/resources/ieefa-india-rise-esg-investing-and-sustainability-reporting

  5. Climate change takes investors beyond the balance sheet to ESG. https://ieefa.org/resources/ieefa-climate-change-takes-investors-beyond-balance-sheet-esg

  6. Guidance Document on ESG Disclosures https://www.bseindia.com/downloads1/BSEs_Guidance_doc_on_ESG.pdf

  7. An Integrated Guide to BRSR. https://www.nseindia.com/resources/research-initiative-corporate-governance-integrated-guide-brsr

  8. SEBI introduces a separate sub-category for ESG investments https://economictimes.indiatimes.com/mf/mf-news/sebi-introduces-a-separate-sub-category-for-esg-investments/articleshow/101990301.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

  9. An Introduction of ESG Disclosures in Indian Regulatory Space. https://www.businesstoday.in/technology/news/story/an-introduction-of-esg-disclosures-in-indian-regulatory-space-part-1-371707-2023-02-28

  10. Environmental, Social & Governance Law India 2024. https://iclg.com/practice-areas/environmental-social-and-governance-law/india

Related Reading:

Previous
Previous

SME IPOs Work!

Next
Next

A Primer on SME IPOs