At the Asian Corporate Governance Association annual meet in mid-November, in an audience poll, there was near unanimity that boards have not come to grips with ESG (Environment, Societal and Governance) and why it matters.
At the Asian Corporate Governance Association annual meet in mid-November, in an audience poll, there was near unanimity that boards have not come to grips with ESG (Environment, Societal and Governance) and why it matters. While this can be in-part be explained by the innumerable standards and reporting formats that exist, the sheer flow of money being invested in ESG makes it hard to understand why boards are not making enough of an effort to have their companies embrace ESG. Let me first turn to the investment numbers.
From being at the fringe when it was first mooted in 2006, by the UN through their Principles of Responsible Investing (PRI), ESG investing is now pretty much mainstream, with US$29.5 trillion invested through various ESG styles and strategies – both active and passive. Europe was the first to adopt this, US is now following (- a survey of 89 asset owners earlier this year found 43% percent incorporated ESG factors into investment decisions, up 21 percentage points from 2013 when the survey was first conducted).
Japan is circling this space – with the Japanese pension fund committing US$ 100 billion to ESG investing. It’s only a matter of time before the rest of Asia, including India catch-up.
For investors, the debate has been whether their fiduciary duty is limited to the maximization of shareholder values or do environmental, social and governance issues matter. And as the debate progressed, the investment styles have evolved from exclusions e.g., we will not invest in tobacco, to ESG integration – where ESG factors are included alongside financial analysis.
While investors were urged to support ESG by becoming signatories to PRI’s, companies were encouraged to observe the United Nations Global Compact, a principle-based framework for businesses. The Global Compact lists ten principles for companies to adhere to, to undertake their businesses responsibly in the areas of human rights, labour and the environment – area’s that were typically seen as being the preserve of governments.
For companies disclosing on these non-financial aspects of their business has been a big challenge, as they are confronted with a multiplicity of reporting standards. There is the Global Reporting Initiative (GRI), the most widely used framework for ESG reporting, International Integrated Reporting Council (IIRC), Sustainability Accounting Standards Board (SASB), Task Force on Climate-related Financial Disclosures (TCFD), Climate Disclosure Standards Board (CDSB) to name just a few. While it is one thing to say that lets get all the data out - a firm in Hong Kong told me that they engaged with ten different data providers (- and this list is growing) to provide ESG data on their company’s operations. One firm sought 800 data points on ‘governance’ alone. Boards will quickly need to decide their alignments, identify the matrices that are material and those that they will track: for a bank’s board to focus on carbon emission makes little sense, but to ignore it for their portfolio companies is not.
The Indian equivalent of the Global Compact is the National Voluntary Guidelines on the Social, Environmental and Economic Responsibilities of Business (Guidelines or NVG). NVG was first rolled out in 2011. It too is a principles-based framework and lists nine principles (- the UNGC lists ten), for companies to observe to undertake business responsibly. Under NVG companies are also expected to exhort their suppliers, vendors, distributors, partners and other collaborators to follow these too.
Since their roll-out in, we have seen a new Companies Act, 2013 – and its amendments, the Listing Agreement was replaced by the SEBI Listing Obligations and Disclosure Requirements (LODR) regulations – and their amendments. Importantly, the entire ESG landscape itself has changed dramatically since. Expectedly, the refresh to NVG-2011 is now close to completion.
A two-member committee was constituted by the Ministry of Corporate Affairs in December 2015. The committee submitted its report mid-2016; extended consultation on these is currently underway. Its recommended among other things is to drop voluntary from the title and call these the National Guidelines on Economic, Environment and Social Responsibilities of Business (NRB-2), so I expect the thrust of these guidelines will be far more pervasive than in its earlier avatar.
What of reporting on NVG-2011? From the start, Securities and Exchange Board of India chipped in, with its BRR – Business Responsibility Reporting framework to help companies disclose on elements that extend beyond numbers. SEBI made BRR reporting mandatory for the top-100 companies in 2012, and in 2016 stretched this to the top 500 companies. The NRB-2 report itself now has a chapter on BRR. If companies have not yet focussed on this report, it is time that they do so: they may well need to start reporting based on these new guidelines for FY19 itself.
As the global debate on climate change, sustainability, income inequality gather steam, investors are increasingly factoring in ESG factors into their investment decisions and in their engagement with companies. Boards on their part need to be aware that ESG factors can and do create significant operational risks and costs to businesses, which has an asymmetrical impact on the reputation of the company. Conversely, strong focus on ESG will enhance productivity and mitigate numerous risks. This is where shareholder value will be created.
A modified version of this blog appeared in Business Standard on 4 December 2018. You can read the article by clicking on this link or typing the following url:https://www.business-standard.com/article/opinion/fifty-shades-of-green-118120400042_1.html