IMPACT OF ESG (ENVIRONMENT, SOCIAL AND GOVERNANCE) FACTORS ON CORPORATE EVALUTION BY: DHOBALE SANKET NARAYAN
IMPACT OF ESG (ENVIRONMENT, SOCIAL AND GOVERNANCE)
FACTORS ON CORPORATE EVALUTION
AUTHORED BY: DHOBALE SANKET NARAYAN
Roll no.- 01
CLASS- LL.M 2nd year
Division: - A
PROGRESSIVE EDUCATION SOCIETY
MODERN LAW COLLEGE, PUNE
Abstract
Recently, there has been significant
research on the environmental, social, and governance (ESG) aspects of wealth generation. Managers have tried to
attract investors for sustainable growth by pushing for ESG investments. This
study attempts to determine the relationship between ESG scores on
shareholders' wealth and define possible selection
criteria for future investments. Notably, there are funds and investment
avenues that are specifically designed for ESG themes, urging toward
sustainable wealth creation. However, investors' focus remains on their returns
and wealth creation. In recent years, reporting ESG scores has become standard
practice for most rating agencies to report the financial health of companies.
Thus, this study employs a linear regression model to analyze the impact of ESG
scores on the equity returns of 225 Indian companies.
The results show empirical evidence of the positive impact of the governance
(G) factor on equity returns, while it reports the negative impact of the
environmental (E) factor on equity returns. Moreover, the impact of the social
(S) factor is found to be insignificant. Therefore, we conclude that financial
motivations may be needed to trigger E? and S- factor practices by companies.
It is important for companies to be very conscious of their governance
practices to improve their shareholders’ wealth.
1) Introduction
The rising demand for a
sustainable future for the world is the result of increasingly growing
apprehension about environmental and social issues. Due to such a prominent
force of demand, it is being recognized by organizations that it is crucial for
every business to showcase transparency in their activities involving any
possible risk associated with the environment, society, and governance.
Environmental, Social, and Governance (ESG) disclosure has come up as a key
tool for numerous regulatory bodies, stock exchanges, and government
authorities to facilitate this transparency.
ESG reporting,
purpose-led performance reporting, or sustainability reporting are some of the
other names by which ESG disclosure can be referred to. The disclosure is an
amalgamation of the data about a company or an organization’s impact on the
environment, society, and governance. As mentioned earlier, these reports serve
the purpose of facilitating the details regarding all the possible risks and
opportunities that the organization may face or is facing, inducing
transparency between the organization and its stakeholders, i.e., investors,
creditors, policymakers, members, employees, existing as well as potential
customers, the government, and society at large, for better understanding about
an organization’s ESG management.
2)
Significance of ESG disclosures
As the name suggests,
the three prime ingredients in determining the feasibility and influence of an
investment in a company or business organization are what comprise the ESG
Disclosures. In order to amplify one’s company’s environmental operations and
drives, it is essential to formulate effective ESG reports. Opportunities of
major significance for a company, such as growing a positive perception of the
public towards the company, being investor-friendly or pioneering the field of
innovation, can be attained by putting efforts into the company’s ESG
disclosures. Being one of the most crucial corporate sustainability strategies,
disclosing ESG data helps companies accurately point out their own
sustainability performance in order to efficiently communicate it to
stakeholders.
a. Purpose of the
disclosures
When investing in a
company or engaging with it at any given level, it can become essential to
evaluate all the key aspects of that company. And whilst undertaking any
evaluation of a company, one cannot overlook the possibility of risks and
opportunities with which the company can be tied. Similarly, another facet that
is something not to be taken lightly is the long-term impact of the activities
that the company is undertaking at present. Now the question arises, how can
someone not working within the company come to know about these crucial aspects
before engaging with the company?
While it is pretty obvious
that it is not possible to know about every possible risk or opportunity that a
company may have, especially for an outsider, ESG disclosure paves the way to
at least know about those risks and opportunities that matter the most after
the financial ones, i.e., environmental, societal, and governance.
Understanding how the
disclosures serve the environment, society, and governance is vital to fully
grasping the purpose of disclosing corporate information.
1) Environment
How a company utilizes
its energy resources and handles the impact of its activities on the
environment as a responsible entity towards the betterment of our planet is
what the ‘environmental’ factor deals with in the disclosure document. Energy utilization,
global warming, carbon emissions, flora and fauna, water treatment, depleting
forest covers, etc. are some of those aspects where companies may have an
impact and this is what the reports disclose to the larger public. Monetary
losses, loss of investment and lower public confidence in the company can
happen as a consequence of not taking adequate steps to counter any of the
mentioned impacts responsibly.
2) Society
The scope of
activities and initiatives that a company undertakes in order to cherish the
value of people and society at large is something that is analyzed in this
factor of the report. The report may include anything of a positive or negative
outcome in relation to a number of important societal issues, such as gender
sensitivity, the working environment of the workforce, customer engagement,
data security and safety, privacy issues, etc.
3) Governance
How a company manages
its internal issues and in what manner it deals with possible legal violations
is what the ‘Governance’ factor addresses. It also focuses on the practices and
procedures that a company follows as a part of its internal management. By
disclosing these vital internal approaches, it is demonstrated that a company
is safe and reliable, making it transparent and investor friendly.
b. Outcome of the work
The work of creating
an exhaustive ESG is a tedious task and has to be done by being mindful of the
outcomes that are expected by disclosing such a report. The key determinants of
an effective ESG report are:
·
Why report ESG information?
·
For whom should ESG information be reported?
·
Where should ESG information be reported?
·
What ESG information should be reported?
·
How should ESG information be presented?
By addressing these
questions, a company can formulate an effective ESG report that can meet the
company’s expected outcomes. For further insights regarding these determinants
and their role in an ESG report, it is recommended to go through the ESG
Disclosure Handbook issued by the World Business Council for Sustainable
Development.
The outcome of
creating an ESG report heavily depends on what the company is looking to
achieve by disclosing the report simply because it will contain the information
that the company is willing to share in order to achieve certain objectives.
While there can be several outcomes of an ESG disclosure, ranging from due
compliance with government policy or statutory guidelines, growing positive
public perception, gaining investors’ confidence, aligning with industry
practice, etc., it is inextricably crucial for a company to accurately define
and decide on what outcomes it is expecting from the disclosure while drafting
an ESG report.
c. Takeaways for a
company
While it has been made
clear by now that ESG disclosures are beneficial for the holistic improvement
of corporate practices because of their influence over the various stakeholders
of companies, it is also vital for corporate houses to know that ESG is not
only beneficial for external stakeholders; rather, it can be used in a number
of ways that can prove to be highly rewarding for the companies.
There are a number of
rewards that a company can attract by efficiently utilizing the opportunity to
invest in ESG. Below are some of the few possibilities over which companies may
want to capitalize.
i.
On boarding with
the competitive environment
With every passing
year, the planet’s ecosystem is taking a hit. This has compelled a number of
big and small corporations to start adopting sustainable practices. “Companies’
awareness and engagement with climate and environmental issues also seem to be
increasing rapidly,” said Mr. Richard Mattson, CEO of Trust core, which is a
part of S&P Global Market Intelligence. This makes it important for other
companies to take ESG seriously, as it can make a difference for them by
turning them into well-performing companies.
ii.
Catering to the
changing consumer choice
According to a report
by PwC published in 2021, around 76% of consumers are willing to discontinue
their relationship with companies that treat the environment, workers, or
society to which they cater poorly. Another study shows that nearly 71% of
consumers in India alone have remained their consumer choices based on the
values that the companies stick with. This trend shows that just shifting to
ESG-friendly practices and disclosing them to the public can help attract a
prospective consumer base that is more than willing to shift to companies
abiding by ESG principles.
iii.
Attracting
investment
The world of investors
is majorly emphasizing prioritizing ESG compliant ventures and it is only going
to grow. Studies show that despite the recent economic and political turmoil,
81% of asset managers from major economies are jacking their priorities in ESG
investment. This paves the way for companies to become the target of such
investors and this can be done by disclosing ESG reports to investors or
associations of investors globally.
The list of benefits
can go on, but to truly reap the benefits and take away the rewards, it is
essential to report ESG data using a standard and framework that is accepted
globally. There are a number of options from which a company can choose.
Following a standard becomes important because it makes it easier for
investors, consumers and other stakeholders to understand the quality of a
company’s sustainability practices.
3) ESG landscape in India
When major economies
are rapidly adopting ESG principles and norms as a basic standard for their
market players, India has not been so active in the reform. Global players and
regulatory authorities are increasingly turning towards ESG practices and their
mandatory adoption, which is also having a major impact on businesses operating
in the Indian consumer market. Not only the businesses are being influenced but
the larger consumer base present in India also has mixed feelings about the
traditional corporate practices that the companies in the country generally
follow.
a. Legal infrastructure
dealing with ESG reporting
Unfortunately, there
are no definite substantive laws or regulations in place in India that
authoritatively direct the trends of ESG reporting or practices in the country
but there are numerous legislations that partially have a say on such issues.
Below are the laws and regulations that have ties to ESG practices in India.
These are some of the
key legal instruments that somewhat regulate the ESG practices in the country
and their disclosure. While there are other environmental laws in place that
specifically address issues related to the environment but are not exclusively
applicable to ESG reporting practices,.
It has to be noted
that it is the Companies Act, 2013 that has the most say and authority over
whatever limited regulation there is on sustainable practices in India. Section
134(3)(m), Section 166, and Section 135, read in sync with the Companies (Corporate Social
Responsibility Policy) Rules of 2014, are some of the key provisions that are
present in the Companies Act with regard to the subject matter.
Apart from the
Companies Act, the Securities and Exchange Board of India (SEBI) is a prime
authority on the subject matter. SEBI, the capital market regulator of the
country, recently replaced the previous mandate of BRR (Business Responsibility
Report) from 2012 with BRSR (Business Responsibility and Sustainability
Report), effective from the 2022-23 fiscal year. The replacement was made
through SEBI’s Regulation 34(2)(f) of the Listing
Regulations and its circular. Now,
the top 1,000 listed entities in the Indian capital market are mandated to
include a BRSR in their respective annual reports, addressing the steps taken
by the listed entities towards ESG principles.
At present, there is
no robust legal infrastructure in India that can deal with ESG reporting and
disclosures. While this is the case, SEBI in May 2022 formed an advisory
committee to develop a robust system of ESG indicators, disclosures, rating and
other regulations for ESG investment. Similarly, the Reserve Bank of India
(RBI) is undertaking several studies and initiatives to develop a holistic
legal and regulatory framework to promote ESG endeavors in the country.
b. Government’s take
on ESG
The Ministry of
Corporate Affairs (MCA) formed a committee on the above-mentioned business
responsibility reporting to finalize the report formats going to be applicable
to the listed as well as unlisted companies. This is going to be based on the
performance as per the nine principles laid out in the National Guidelines on
Responsible Business Conduct (NGRBC), released by the MCA. The report of the
said committee proposed the extension of the number of BRSR-mandated companies
to unlisted companies having turnover or paid-up capital above a certain
figure. It is also recommended that the unlisted companies of small scale adopt
BRSR Late.
While it is evident
from the recent developments that the Government of India is taking ESG and its
related issues seriously, there remains a gap that needs to be bridged soon. It
is yet to be seen what further steps the government will take to further strengthen
the legal framework related to ESG disclosure in the forthcoming years.
c. Initiatives in
the business environment
Corporate giants in
India are driving the ESG tide and it is only going to grow more. The
importance of ESG and its disclosures has been realized by a number of
businesses in the country and they are adopting practices that are compliant
with ESG principles. This can be seen by the fact that giants like TCS and
Reliance Industries have announced their roadmaps to reduce their carbon emissions
to zero. Another prominent case is the affiliation of tech giants like Tech
Mahindra, Infosys and Wipro with the Dow Jones Sustainability Index (DJSI), a
benchmark for assessing the ESG performance of companies throughout the globe.
There are a number of
other examples where companies are willingly taking initiatives towards the
betterment of the people. In India, the trend of companies taking part in ESG
initiatives is constantly on the rise and with such things happening, it is
quite obvious to witness the sudden surge of the need to disclose the same
thing to the relevant audience.
4)
A glance at global ESG standards
For a long time, there
was a lack of a common standard on which companies could frame their ESG
disclosures. The global ESG standard varied a lot and had a lack of uniformity.
This is going to change very soon, as the International Financial Reporting Standards
(IFRS) Foundation has recently formed the International Sustainability
Standards Board (ISSB) with the objective of formulating international
standards of sustainability disclosure. According to the IFRS Foundation, the
ISSB’s standards will have international support from the G7, the G20, the
International Organization of Securities Commissions (IOSCO), the Financial
Stability Board, African Finance Ministers and Finance Ministers and Central
Bank Governors from more than 40 jurisdictions.
The International
Sustainability Standards Board (ISSB) issued its first two standards, namely
IFRS S1 and IFRS S2, on June 26, 2023. While the IFRS S1 creates an
international baseline for general sustainability disclosures, the IFRS S2
specifically deals with the standard for climate-related disclosures.
a. ESG standards in
the US
The case for ESG
disclosure standards in the United States of America until sometime ago was
very similar to that of the case in India, where the disclosures were mainly
driven by voluntary initiatives from the companies. However, it has changed
rapidly over the last few months, as the U.S. Securities and Exchange
Commission (SEC) has introduced new ESG initiatives and proposals.
Now, the SEC requires
every publicly traded company to disclose all the material information that can
be crucial for investors, including ESG-related risks. There are a number of
other proposals that the SEC has introduced to the Biden administration in the
US. Along with these, the SEC is also looking to align its standards and norms
with the recently released standards of disclosure by the ISSB. By this, it can
be said that in the upcoming months, some major changes and amendments to the
existing regulations for ESG disclosures can be expected in the US.
b. ESG disclosures
in the EU
Unlike its US
counterpart, the European Union (EU) recently adopted the Corporate
Sustainability Reporting Directive (CSRD), which has made it mandatory for all
EU and non-EU companies having their business operations running in the EU to
file annual reports on sustainability and the reports have to adhere with the
European Sustainability Reporting Standards (ESRS). As of 31st July
2023, the European Commission has adopted ESRS.
ESRS will standardize
the manner in which companies in the EU report their ESG actions to the
European Commission. Now all the 27 member countries have to include the ESRS
in their legal framework by early 2024.
The ESRS has 12 sections, divided into four categories of
reporting:
1.
General;
2.
Environmental;
3.
Social;
4.
Governance.
While the ESRS has
been developed by the European Commission, one has to understand that the ESRS
has been formulated in such a way that it corresponds to the ISSB developed by
the IFRS as well. To increase the coordination between the two sets of
standards, the European Commission has announced that it is closely working
with ISSB to achieve the same.
5)
ESG standards
in other major economies
Another major economy
that has a robust legal framework regulating the standards of ESG disclosures
is China. ESG disclosure regulations in mainland China were introduced way back
in 2008. The companies listed in the Shenzhen 100 Index were required to disclose
their social responsibility reports to the Shenzhen Stock Exchange. The
Shanghai Stock Exchange has mandated its Corporate Governance Index listed
companies, be they domestic or international, to disclose their social
responsibility reports, which have been further transformed into ESG reports.
China formally established its framework for ESG disclosures when the China
Securities Regulatory Commission (CSRC) released the Code of Corporate
Governance Guidelines for Listed Companies in 2018.
Similarly, Singapore
has also adopted clearly outlined ESG standards for their jurisdiction’s ESG
disclosures. The Singapore Exchange has come up with a list of 27 core ESG
metrics for companies to use as a starting point for ESG disclosure. While the
Singapore Exchange has recommended the standard, it is not a mandatory standard
that companies are bound to follow; rather, it is a suggestive approach when
formulating an ESG report. This means that companies in Singapore are free to
follow any standard of ESG reporting.
6) India’s spot in the rising ESG standards globally
It is a long-standing
trait of Indian lawmakers to keep a slow pace when legislating on developing
areas of public interest. This has been the same case in forming a standard for
ESG disclosures in the country. However, it is true that India was the very
first country to make law-making CSR mandatory when it introduced the statutory
provision for CSR in Section 135 of the Companies Act in 2014. The Government
of India and its financial regulatory wings have been taking a slow approach
towards developing a standard framework to consolidate the ways in which ESG
disclosures are made today or are not made at all.
While the world is
moving towards an internationally accepted standard of ESG reports and
disclosure, India has yet to come up with some substantial regulations in its
domestic markets. As mentioned previously, the IFRS’s ISSB has already issued
its set of international standards, and to comply with the same standards, the
US government and EU’s regulatory space are working tediously. And as it is
very well known that the G20 is one of the key supporters of the ISSB, it
brings up the question of why India is not working to align itself with the
ISSB’s proposed framework despite being one of the key members of the G20
group.
It is high time that
India takes the ISSB’s proposals and the growing need for some substantial ESG
regulation seriously, prioritising bringing a robust mechanism to regulate ESG
practices and disclosure in the Indian market because limiting the regulations
to a handful of companies from the capital market is not going to do much good,
which is in itself a concerning issue in the light of a collective push for
global sustainable practices.
7) Way forward with ESG disclosures
ESG has been taking an
important spot in the to-do list of businesses and organizations globally. It
is a positive trend that needs to grow even more because it will play a pivotal
role in attaining the sustainable goals of our planet in the future. While it
is true that ESG practices and disclosures have shown significant growth in the
past few years, there is a massive need to increase the same even further, and
that too at an exponential rate. To meet the future needs of the planet, it is
necessary to pace up the adoption of CSR activities and their disclosures
through ESG reports.
a. Rising importance
of ESG compliance in India
India has been
witnessing a rise in new businesses and foreign investment in its domestic
market in the past few years. This has made sure that the Indian economy grows
to become one of the biggest economies in the world. With more and more people
setting up their businesses in India, it becomes even more important to monitor
the quality of practices that these new businesses follow and ensure that no
business practices in a manner that has a destructive effect on nature, the
people or the national interest of the country.
The Ministry of
Corporate Affairs (MCA), Reserve Bank of India (RBI), and Securities and
Exchange Board of India (SEBI), along with some other key government
institutions, play a key role in the business affairs of the country and it is
up to them to ensure fair and safe practices to be the topmost priority of all
the organisations participating in commercial activities in the Indian
jurisdiction. It is more than evident that ESG disclosures are important for a
lot of stakeholders and therefore, providing a definite standard of ESG reports
becomes a necessary step towards meeting the country’s Sustainable Development
Goals.
With only a limited
number of regulations on ESG disclosure, India needs to introduce new and more
effective policies, guidelines, standards and frameworks that can bridge the
gap. The new developments have to also comply with the ISSB’s proposed global
standard in order to make it easier for global investors and trade partners to
operate in the Indian financial market.
b. Globally evolving
ESG standards
The world is
witnessing substantial development in the standards of ESG disclosure at
international and global stages. This proves the fact that governments and
international bodies all over the world are coming to a consensus on the
importance of regulating ESG reporting. The establishment of the ISSB is a key
milestone towards regulating global ESG standards. This positive development
and the ISSB’s importance have been accepted by several global leaders,
international forums and UN member states.
The joint statement by
the UN entities states, “The standards being developed by the ISSB
provide a unique opportunity. They can support global convergence of
sustainability-related disclosure, create a common reporting baseline, and help
mainstream sustainability-related issues into regular business strategy and
management.”
The newly formed ISSB
is going to play a major role on a global level in maintaining and regulating
the standards of ESG reporting that the nations and companies operating in
those nations will follow. The first set of standards has already been released
by the ISSB, with many more to be released in the near future.
8)
Conclusion
We are going through a
period of transition where the world is changing its attitude towards the
planet and the life on it. This junction of transformation brings its own
challenges, which need to be resolved by a joint effort from all the
stakeholders. The primary face of this change has been governments all around
the world but it is high time that private players also take on the burden of
moving forward with sustainable development goals.
To ensure that the
interests of everyone, including businesses, investors, governments, the
public, society and nature, are met while advancing, ESG reporting has become a
unique and effective medium. But this medium has to be standardized at a global
level in order to make it useful for everyone and fulfill its purpose.
Understanding the
standards of ESG disclosures in India and its global counterparts is
strategically crucial for all businesses, investors, government bodies, and
consumers in India in order to align themselves with such norms seamlessly.