Environmental, social and governance factors: ESG compliance needs clear rules

February 19, 2021 7:00 AM

For sustainability reporting to be a more meaningful tool for growth, regulators must associate financial materiality to the relevant E, S, and G factors

A 2020 OECD study on global ESG practices noted enhancement in data availability and analysis but said further strengthening of ESG practices was needed.A 2020 OECD study on global ESG practices noted enhancement in data availability and analysis but said further strengthening of ESG practices was needed.

By Jignesh Thakkar

Environmental, social and governance (ESG) factors have gained global relevance as key indicators for long-term value creation. ESG reporting requires organisations to demonstrate integration of sustainable development practices in their operations. The environmental criteria are factors related to climate change. The social criteria include labour relations, diversity and contribution to communities. Governance incudes internal practices, controls, and stakeholder engagement. Collectively ESG works to unlock a companies’ resilience and portray a positive view of the company’s performance to investors. A July 2020 survey by EY finds that 91% of institutional investors review non-financial disclosures of companies for investment decisions. An NSE analysis of ESG risks in 2020 revealed better policy disclosures and governance by companies than environment and social factors. Strong policy disclosure comes from regulatory push, but doesn’t translate into a letter and spirit adoption of ESG principles by India Inc.

In 2012, SEBI mandated the top 100 listed companies to file Business Responsibility Reports (BRR). This followed the ‘National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business’ (NVGs). BRR included specific disclosures and steps taken to implement ESG principles, and was extended to the top 1,000 companies in 2019-20. Stewardship Codes issued by market, insurance and pension regulators asked institutional investors for clear policies on intervention in their investee companies, including ESG risk assessment. A SEBI paper of August 2020 proposed a voluntary format for Business Responsibility and Sustainability Reporting (BRSR) for the 1,000 largest entities by market capitalisation. BRSR is likely to be mandatory next fiscal.

A 2020 OECD study on global ESG practices noted enhancement in data availability and analysis but said further strengthening of ESG practices was needed. Currently, ESG scores depend only on non-standard, limited data making this difficult to analyse. ESG scores across geographies need to be consistent, comparable and of the same quality. Some elements of this study, like common core metrics for E, S, and G being consistent across industries and size as well as sector specific metric, were echoed by industry leaders in a January 15, 2021 conference held at SEBI.

In a 2020 survey conducted by EY, 46% of investors found a challenging disconnect between ESG reporting and financial information. For sustainability reporting to transition from a burdensome compliance obligation to a more meaningful tool for growth, it is important for regulators to bridge the gap and associate financial materiality to the relevant E, S, and G factors.

Other Indian studies indicate companies make disclosures with their own interpretation of data points with focus on quantitative data. BRSR reporting seeks to address these gaps with key qualitative indicators such as stakeholder identification process, communication channel, consumer complaints redressal, steps to mitigate adverse environmental and societal impact, etc.

Worldwide, ESG disclosures are being consolidated through a variety of channels. There is also the need to explain the methodology for data collection, disclose weightage given to various metrics and weighted pillar average to arrive at comparable ESG scores across the companies. While there is an attempt to standardise the metrics to some extent, there should be regulatory guidance and clarity on how to apply these metrics and bring about uniformity in data collection practices.

Formation of ESG implementation team with internal and external stakeholder engagement, investing in assessment tools based on global leading practices, and appropriate trainings for people on ground will help in establishing long term gains for the corporates through ESG reporting and scoring. ESG commitment has to echo in the top-down approach and regulators could even consider making this as part of directors’ fiduciary duties. Through effective regulatory guidelines, sustainability reporting will not only be more meaningful, it will also shift the check in the box compliance approach to the desired long-term growth perspective for India Inc.

With inputs from Versha Goenka, director, business consulting, EY

The author is Leader (global compliance solution), EY
Views are personal

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