Explained: Growing popularity of ESG funds and the recent Sebi guidelines

Recently, market regulator Sebi announced a slew of measures to boost ESG-based investing in India through mutual funds. The fund houses have been given the freedom to launch more than one ESG scheme now.

"Though the step is emerging, it is opening a myriad of options for the investor community to invest in funds or a pool of companies that are adopting the ESG risk management framework, promoting social welfare, and having oversight on sustainability targets. Sebi’s norms for third-party assurance on the ESG scheme and the fund manager’s commentary will bring more credibility to such ESG funds," Prosenjit Ghosh, Group Chief Business Officer at Acuite Group, told CNBC-TV18.com.

Sebi has mandated AMCs to provide disclosures on votes cast on resolutions of environmental, social or governance issues. The move by the regulator is also favourable for the investor community that is keen to invest in green funds, sustainable funds, and impact funds.

The environmental issues have expanded from the adoption of renewable energy to carbon pricing and carbon offsets. On the other hand, social issues in the areas of data privacy and security, diversity and inclusion have become very critical.

The challenge for companies, Ghosh said, lies in measuring, monitoring, and reporting.

"With Sebi mandating Business Responsibility Reporting (BRR) in 2015 and further Business Responsibility Sustainability Reporting (BRSR) in 2022, the disclosure levels of companies have improved. As per ESGRisk.ai, transparency scores that reflect the disclosures of companies have increased from 48.7 in FY19 to 58.5 in FY21 for NSE top 1000 companies," Ghosh told CNBC-TV18.com.

Sebi has mandated mutual funds to invest at least 65 percent of AUM in listed entities. Investors are increasingly looking for companies that make a positive impact on society and the environment. Proper disclosures along with evidence will improve the quality of reporting.

There are many colours of ESG misreporting by companies as part of their Annual Report or Sustainability reports, such as greenwashing stakeholders and the public being misled about the organisation's environmental impact and/or initiatives. Then there is pinkwashing as well as whitewashing.

Greenwashing is an exaggerated claim about something's sustainable. On the other hand, pinkwashing is when entities practice fake advertising support to the LGBTQIA+ community.

Whitewashing means where entities report biased ESG data, etc.

"In such cases, if the AMC is aligning its ESG investment strategies and complying to only invest in companies that have assurance for core ESG parameters, and where the objectives of the scheme are met, then mis-selling of ESG funds is prevented. Further, the mis-selling of funds is possible where the fund manager is not factoring in the impact of the controversy or monitoring only financial indicators and diluting the significance of ESG parameters. It is very important for AMCs to have clear objectives for their ESG schemes and create a screening process for selecting and monitoring the portfolio," Ghosh told CNBC-TV18.com.