By Mukund Govind Rajan
As another Earth Day dawns, we have ever more evidence of the toll humankind is taking on the planet. The latest report of the Intergovernmental Panel on Climate Change asserts that the rise in weather and climate extremes has led to “irreversible impacts as natural and human systems are pushed beyond their ability to adapt.” And as if to underline the limitations of the kind of international diplomacy that will be needed to resolve global environmental challenges, the Russia-Ukraine conflict continues to take a severe toll on human life and the natural environment.
Driving the ESG Agenda
The good news, if it can be termed thus, is that black swan events like COVID 19 and extreme climatic events caused by global warming, by testing the resilience of businesses around the world, have triggered a major new thrust on Environment, Social and Governance (ESG) performance. Forward-looking enterprises recognize that by improving their performance on material ESG metrics such as natural resource consumption and waste discharge (the E of ESG), diversity and inclusion (the S of ESG), and board effectiveness (the G of ESG), they can gain competitive advantage, achieve greater long-run returns, and build resilience.
Diverse stakeholders are driving the ESG agenda. Customers, especially younger generations and Gen Z, are increasingly demonstrating a preference to embrace purpose-driven consumer brands that clarify their ESG commitment. Communities, well-informed through social media and ubiquitous access to the world-wide web, are demanding a better quality of life. COVID 19 has played its role, demonstrating that when nature revolts, there is nowhere to hide, no matter how powerful or wealthy you might be.
The judiciary is also speaking the language of quality of life. The Indian Supreme Court’s seminal judgment of 2018 on the migration timelines that were speeded up from Bharat Stage IV to Stage VI fuel emission norms, impacting the auto industry, is a case in point. The Court held that that the right to life includes the right to a decent environment, and the larger public interest has to outweigh the much smaller pecuniary interest of industry.
Close scrutiny is now taking place, by public policy institutes, non-profits and others, of the performance of businesses on the Sustainable Development Goals or SDGs defined by the United Nations, traversing issues ranging from poverty alleviation to addressing climate change.
In step with the growing expectations of diverse stakeholders, governments are promulgating rules and regulations that enhance the responsibility businesses carry, and the quality of disclosures they make. In India, beyond sector specific rules, such as plastic waste management and extended producer responsibility rules, the government has designed the ‘National Guidelines on Responsible Business Conduct’, to mainstream the concept of Corporate Responsibility. These guidelines have been integrated into the Business Responsibility and Sustainability Reports that SEBI has directed the top 1000 listed companies to publish, on a mandatory basis from this fiscal onwards.
Stewardship Codes are also being prescribed by regulatory authorities for institutional investors. In India, such Codes have been mandated by SEBI for mutual funds, IRDAI for insurance companies, and PFRDA for pension funds. As a result, these institutional investors are beginning to put pressure on companies to do better on ESG. One reflection of this is the greater scrutiny and rising “against” votes by them when voting on shareholder resolutions, on issues such as corporate governance or executive pay.
Perhaps the most critical impact is being created by investors. By some measures, ESG investing is now a $43 Trillion industry accounting for half of all new investing in the European Union, and up to a quarter of fund flows in North America. Globally, entities controlling over $120 Trillion of invested funds around the world have subscribed to the United Nations Principles for Responsible Investment (UNPRI), which require them to incorporate ESG issues into their investment analysis and decision-making processes.
This growing momentum of ESG investing owes significantly to powerful correlations being drawn between performance on ESG and operational and financial performance. There is now a great deal of academic literature to show that a greater focus on ESG typically yields greater resource use efficiency, lower cost of operations, reduced risk, lower cost of borrowing and greater prospects for valuation rerating.
Though the space is relatively nascent in India, there is useful data available from, for instance, the MSCI India ESG Leaders Index, which has outperformed the broader benchmark index in terms of returns for most periods of time, including the past three, five and ten year periods. As a major percentage of business value moves towards intangibles, by some accounts as much as 90% of the value, ESG metrics are increasingly defining the market’s receptivity to individual businesses.
No More Business As Usual
There is now a palpable sense of urgency amongst a number of Indian companies in embracing the ESG agenda. They recognize that Business As Usual will no longer work.
Key actions these companies are taking include establishing the right governance structures at the level of the Board and the senior management to develop ESG strategies spanning “material” ESG issues. Companies like Infosys, Ashok Leyland and Airtel have created dedicated ESG Committees of the Board. Several, like Marico and Welspun, are forcing the pace of change by linking performance on strategic ESG issues like carbon emission reduction and better water management to senior executive compensation.
Forward-looking businesses are also focusing increasingly on the circularity of their operations, with a determination to reduce or eliminate waste. A number, including India’s largest private sector enterprise, Reliance Industries, are specifically acknowledging the climate change issue, and setting Net Zero targets.
These companies are also investing significantly in R&D and innovation. They are pivoting business models, as in the case of Tata Power with its move towards renewable energy and away from coal-fired thermal power. New opportunities emerging across areas like green hydrogen, Electric Vehicles (EVs), high efficiency materials, biomass to energy and meat alternatives are all being targeted by businesses, both large established enterprises as well as start-ups, working ahead of regulation and influencing the shape of things to come.
Challenges and Opportunities
Notwithstanding the considerable good work happening across the corporate landscape, there are clearly challenges that lie ahead. These include the specific needs the MSMEs have in undertaking ESG transitions, including improved governance, awareness building and technology and financing support. On the social dimension, Corporate India has a major challenge on its hands to improve its Diversity and Inclusion profile, including the representation of women and members of the Scheduled Caste and Scheduled Tribe communities. And key to India’s Climate and Sustainability transition will be the availability of sustainable financing.
Every credible analysis of India’s sustainable financing needs suggests a requirement of over $1 Trillion within this decade alone, to meet the enhanced ambitions announced at the Climate Conference in Glasgow last year and India’s other sustainability goals. Bold steps will be needed on expanding sustainable financing within the framework of RBI mandated priority sector lending, and developing blended finance solutions. More risk capital will be required from the private equity and venture capital industry, and innovative solutions from private lenders in spaces such as leasing finance for the emerging electric vehicle ecosystem. On the foreign capital side, access needs to be expanded by creating more flexibility and reducing constraints such as the minimum average maturity for external commercial borrowing.
India’s sustainable financing needs will have to be underpinned by a Sustainable Finance taxonomy that gives both domestic and foreign investors comfort, and pre-empts the dangers of greenwashing. This will require building an ecosystem of entities like assessors, verifiers and valuers. Alongside, a national trading platform will have to be constructed, where all manner of sustainable finance products, including climate bonds, gender bonds, social bonds, carbon credits and the like can be easily exchanged. The future is full of risk, but for visionary business leaders, it also spells opportunity. The race to a sustainable future is truly on!
(The author is Chairman, ECube Investment Advisors. Views expressed are personal and do not reflect the official position or policy of FinancialExpress.com.)