ESG: New Age Financial Reporting in India Challenges for Future.
| Author | Dhameja, Nand L. |
| Position | Environmental, social, and governance |
Introduction
Environmental Social Governance (ESG) criteria is a subset of non-financial indicators, it includes sustainable environmental, ethical, social and corporate governance parameters and is exerting greater influence on the development and financing of organizations including public organizations. In fact ESG is described as synonymous with good business and corporate sustainability.
ESG: Origin
"The story of ESG investing began in January 2004 when former UN Secretary General Kofi Annan wrote to over 50 CEOs of major financial institutions, inviting them to participate in a joint initiative under the auspices of the UN Global Compact and with the support of the International Finance Corporation (IFC) and the Swiss Government. The goal of the initiative was to find ways to integrate ESG into capital markets" (Forbes). One year later (2005), an environmental policy work, Ivo Knoepfel, in his paper titled "Who Cares Wins: Connecting Financial Markets to a Changing World" contained recommendations by the financial industry to better integrate environmental, social and governance issues in analysis, asset management and securities brokerage. The corporate collaborators included big names, World Bank Group, Morgan Stanley, HSBC, Goldman Sachs, Deutsche Bank, UBS, Mitsui Sumitomo Insurance, Citigroup and others; and just like that, ESG was born (Wood, March 03, 2022)
ESG stands for "Environmental, Social, Corporate Governance" and is generally measured by a globalized Social Credit Scoring system. If one has a high ESG score, it will be easy to qualify for credit, to get the best deals with vendors and to participate in the global supply chain. Alas, if one doesn't have a high ESG score, it may be difficult to have long term sustainable operations, unless there is a change in business approach. So, how is ESG determined and who sets the rules and guidelines?
First, ESG has nothing to do with the physical aspects of a company, like capital, cash flow or profit. Rather, it focusses on intangible factors pertaining to business approach of a firm, its vendors and customers adherence to Sustainable Development and Climate Change policies.
Accounting regulating bodies emphasize on financial statements which primarily require reporting on financial performance in terms of funds deployed, activities generated, efforts involved and results- all in financial terms. There is absence of any requirement to report on aspects relating to environmental, social and governance and risk arising there from; though over the years, supplementary statements covering energy, pollution control, R & D, aspects relating to remuneration of employees, contribution towards corporate social responsibility, are prepared by corporations. In addition, certain public enterprises have a system of memorandum of understanding (MOU) for planning, control and performance evaluation by following financial as well as non-financial parameters using "five-point scale" and "criteria weight" which result in calculation of "composite score" or an index of the performance of the enterprise.
This paper discusses ESG framework; financial matters reported as supplementary statements; why does ESG matter? pronouncements by international bodies; ESG and UN Sustainable Development Goals (SDGs); ESG and CSR differentiation; ESG among emerging markets; ESG developments in India; ESG and SEBI requirements; ESG research studies by credit rating agencies like CARE and CRISIL. The paper also presents ESG matrices and the methodology for development of such matrices; Way ahead for further research relating to ESG is presented at the end
The idea of judging a company by its social good really started gaining traction in the 1980s when people began exerting pressure on companies not to do business in South Africa to protest apartheid. Later, in the early 1990s, the Body Shop became a dominant retailer of lotions, shampoos and soaps because of the way it advertised its sustainability efforts and outreach to disadvantaged communities (Stacy, September 10th, 2021)
Covid-19 and financial crisis during 2008 gave a call to overhaul the existing system of financial performance assessment indicators and so the emphasis on ESG metrics. Report of Organization for Economic Co-operation and Development (OECD) states that ESG investing can, under certain conditions, help improve management and lead to returns that are either equivalent or superior to those from traditional financial investments. Similarly, as per UN, investment in non-ESG companies could bear up to 28 percent more risk annually compared with ESG-integrated companies in the same industries. Hence, the incorporation of ESG factors could lead to lower volatility in a company's shares, thereby mitigating potential risks (CRISIL, June 2021)
Issues have been raised at annual general meetings by minority shareholders and institutional investors and have voted more actively on issues such as compensation, performance-based remuneration, related party transactions and payment of royalty to parent companies. Rejection of pay hike of Siddharatha Lal, MD & CEO, EICHER Motor; of BVR Mohan Reddy CEO, Cyient, formerly Infotech Enterprises; of Kevin Johnson, CEO Starbuck, are some instances.
ESG is about the UN's sustainable development goals (SDGs) set in 2015, and social responsibility; and these are spokes around the hub of corporate social responsibility or CSR. In a way, becoming accredited in CSR, a company fulfils ESG requirements.
ESG and social responsibility are becoming more important to customers, employees, and shareholders; and there is a heightened level of awareness of ESG (environmental, social, and governance) issues in the companies that people buy from, work for, and invest in. Importantly, people are willing to put their money where their mouth is when it comes to these critical factors (Stuart, 2021).
Indeed, the case for ESG is rising across all levels of organizational hierarchies, including the Board of Directors. A report from the Enacting Purpose Initiative states that "the purpose of business is to solve the problems of people and planet profitably, and not profit from causing problems." In order for companies to live up to their purpose, they must be able to measure their ability to solve problems and not create harm (Joly, May 13, 2021).
The need for ESG reporting has become so salient that even CEOs are now asking for regulation. Research from Fortune, titled CEOs are calling for more regulation--of ESG standards, the majority of CEOs surveyed express a desire for the SEC in the USA to impose ESG reporting requirements. (Murry and Dunn, August 12, 2021)
As reported in a CRISIL Research Study, ESG has entered policy parlance of top economies; about 50 of the leading economies today have policies to drive sustainable investments. The EU, Canada, the US, Israel and many others are bringing out regulations especially on sustainable finance disclosures. These regulations support national policy goals on climate change and the UN's sustainable development goals (SOGs). A growing number of central banks and supervisors have also committed to support climate-related financial disclosure reporting, with a consensus that climate change forms an essential part of financial risk (CRISIL, June 2021)
Major progress towards a global convergence of ESG reporting standards was made at the climate conference in Glasgow with the establishment of the International Sustainability Standards Board (ISSB) in November 2021: a new effort to merge many ESG disclosure standards into one, and to encourage the uptake of these standards globally. (ISSB, Nov. 2021. https://movingworlds.org/esgreporting-guide).The ESG disclosures are now mandatory in more than 25 countries. The format of disclosures is not firmed up and companies provide disclosures as per GRI, SASB etc.
In India, ESG disclosures are mandatory for top 1000 listed companies by market capitalization. As the format of submission varies, SEBI has mandated a standard format (pretty detailed) required from the financial year 2022-23. Though ESG metrics currently are not required of financial reports for publicly traded companies, or organizations; a growing number of companies in India are including these as separate statements namely, initiatives to control pollution, R & D, Corporate Social Responsibility (CSR), (and now also mandatorily required Business Responsibility and Sustainability Report (BRSR), remuneration policy of employees, and other aspects of interest to stakeholders. These are appended in Annexure A at the end. Increasingly, there is consensus among many regulators that some form of standardized ESG disclosures would be required of publicly traded companies on most major global stock exchanges.
ESG criteria though is gaining prominence and has made substantial progress in analyzing and assessing the sustainability of social and development projects in developed countries; emerging economies are in the process of making some inroads; and this is discussed in the following pages.
Some International Frameworks
Despite the absence of international consensus regarding ESG disclosures, a number of frameworks and indices have emerged to guide company disclosures and inform investors; Some of the leading international frameworks include the Global Reporting Initiative standards, the Sustainability Accounting Standards Board (SASB) standards, the United Nations Principles for Responsible Investment and the United Nations Sustainable Development Goals. Ratings...
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