Whom should corporations serve —shareholders or society — was a debate triggered between two professors of law in the early 1930’s. Should corporations only be driven by profits or do they also serve a larger purpose? A seminal paper anchored by the UN titled Who Cares, Wins, used the ESG terminology for the first time to indicate Environment, Social and Governance.
The UN report highlights the need for sustainable development — today ESG has not just become fashionable buzz words, but an acknowledgement that that these are critical for the future of society and mankind.
The Environmental pillar is the most urgent, and the most challenging as well. Emissions such as greenhouse gases, resources such as whether virgin or recycled materials, use of water resources, land use and deforestation and biodiversity, all fall under this pillar.
The Social pillar seeks to address issues relating to employee development, labour practices, health and safety standards, gender issues. Governance seeks to address shareholder rights, board diversity, compensation issues and corporate behaviour with a focus on integrity. Obviously not everything will apply to all companies. Regulators the world over have put in place reporting requirements and seek to closely monitor ESG performance.
ESG has evolved in India over a period of time. ESG issues in some form or other were being addressed through various legislations — The Factories Act 1948, Environment Protection Act 1986, Air ( Prevention & Control of Pollution) Act 1981, Water (Prevention & Control of Pollution) Act 1974, Hazardous Waste (Management, Handling & Transboundary Movement) Rules 2016, Companies Act 2013, Securities & Exchange Board of India (SEBI) (LODR) Regulations 2015, Prevention of Corruption Act 1988 — bits and pieces strewn across various regulations all aimed to address various aspects of ESG.
Corporate Social Responsibility
The year 2009 saw the voluntary concept of corporate social responsibility (CSR) being introduced by the Ministry of Corporate Affairs (MCA) for the first time. Companies were encouraged to put in place a CSR policy, allocate specific amounts in their budget — to ‘bridge the gap between India and Bharat’.
In 2012 SEBI prescribed the Business Responsibility Report (BRR) for top 100 listed companies by market cap. This was in the backdrop of the MCA introducing the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business in 2011. The focus of BRR was on capturing non-financial performance — on ethics, transparency, accountability, sustainability, promoting well-being of employees, respect and protect environment.
The Companies Act was amended in 2015 mandating companies with a profit above a certain threshold to spend at least 2 percent of their average net profits over the previous three years on CSR activities. The Bombay Stock Exchange in 2018 published the Guidance Document on Environment, Social and Governance Disclosures for listed companies in India — again a voluntary requirement.
The SEBI in 2021 expanded the BRR concept. New reporting requirements on ESG parameters called the Business Responsibility and Sustainability Report (BRSR) were prescribed. The BRSR sought disclosure from listed entities on their performance against nine principles of the national guidelines on responsible business conduct which had been prescribed in 2019 by the MCA.
The principles ranged from governance with integrity, functioning in a sustainable and safe manner, respect, the well-being of employees, the interests of stakeholders, human rights, environments, to businesses functioning in a responsible and transparent manner and promoting inclusive growth and equitable development. The 2021 SEBI circular was made mandatory for the top 1000 listed companies by market cap from 2022-23 —this showed the intent and concern of the regulator.
In July 2023 SEBI issued a mandate for the top 150 companies to prepare disclosure and reasonable assurance on BRSR Core KPI (a subset of BRSR) from FY 2023-24 onwards. BRSR was extended also to the supply chain of listed companies from FY 2024-25.SEBI also introduced a regulatory framework for ESG Rating providers ( ERP’s) from July 2023.
ERP’s had to register themselves with SEBI; several disclosure norms and procedures were prescribed. What gets measured gets done — ERP’s were mandated to offer at least six specified rating products including core ESG rating and core transition rating. A detailed FAQ was also issued in December 2023 for ERP’s —the key development being the Chinese wall between a credit rating agency (CRA) and a ERP being relaxed with sharing of resources now permitted. The Reserve Bank of India (RBI) in recognition of the fact that the financial sector plays a critical part in mobilising resources to green activities/projects also came out with a framework for acceptance of green deposits.
ESG Accountability
Thus slowly but surely the Indian regulators have moved towards ensuring greater ESG accountability. Globally too this has been the development. Be it EU which in 2022 passed the Corporate Social Responsibility Directive ( CSRD) or the US Securities and Exchange Commission (SEC) which proposed rules to enhance and standardise climate-related disclosures, the aim has been to enforce ESG principles. Real world concerns especially climate change as eloquently voiced in COP 28 have driven these developments .
The challenge with regard to ESG is to measure the impact of the mandatory requirements. Carbon emissions remain unprecedentedly high; social issues are difficult to measure and corporate governance is often opaque. The Economist has in a recent issue advocated overhauling ESG to cut down subjectivity. The need for standardisation of matrices across ESG rating agencies is undoubtedly essential. But this is criticism which perhaps begs the question — is not ESG critical?
Admittedly it is not a panacea for all the environmental ills but it certainly does empower conscientious investors to evaluate firms on parameters other than the balance sheet; it makes greenwashing difficult. As Deloitte has pointed out in a recent survey, ESG driven investments have seen a spurt in India — 1 out of 5 US$ VC investments was ESG oriented. The same report indicates that companies that increase their ESG score have also seen a boost in their EBITDA. This, more than anything else, demonstrates that the investor perceives ESG performance as a driver of value creation — not merely a compliance requirement.
Regulations and mandatory disclosures can be effective only when all stakeholders acknowledge and recognise the fact that what we do or not do today will impact future generations. Adherence to ESG requirements will add to costs — but this is money well spent.
—The author, Najib Shah is Former Chairman, Central Board of Indirect Taxes & Customs. The views expressed are personal.
(Edited by : C H Unnikrishnan)
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