WHY IS IT BECOMING IMPORTANT FOR INDIAN COMPANIES TO IMPLEMENT ESG POLICIES?
INTRODUCTION TO ENVIRONMENTAL AND SOCIAL GOVERNANCE
Every business is deeply intertwined with environmental, social, and governance (ESG) concerns. Therefore, a strong ESG proposition can create value for it. Environmental, social, and governance (ESG) criteria are a set of standards for a company’s behaviour used by socially conscious investors to screen potential investments. Applying this approach leads to conscious decision-making that takes care of both, the business as well as the society and the environment.
WHY IS ESG IMPORTANT FOR BUSINESSES
It’s appropriate to establish that today’s market and economy run on a capitalistic approach and the end goal of every business is to maximise its earnings and profits. Such an approach often comes at the cost of harm to the environment and disregards the social responsibilities that the entity owes.
What earlier used to be a vague topic of discussion has now become an investing priority keeping in mind the environmental sensitivity of these times. But implementing policies that take care of the environment and society has proved to be very beneficial for businesses in the longer run. What often comes as a result of not adhering to the ESG guidelines is physical hazards such as the damage that natural disasters do to the infrastructure and property as well as creating financial risks by way of losses and liabilities. Due to the disregard for social and environmental laws, the business could also face negligence claims against them.
Another very important aspect for a business to be successful is to earn the trust of its customers. Even the customers have become very socially aware and sensitive now and want to ensure that they are buying or rendering services that are ecologically and socially beneficial. By following proper ESG policies, the companies also gain their customers’ trust and build an image for themselves in their eyes making it crucial to integrate ESG into the corporate structure of the business.
With the rising significance of ESG in India, investors will not just get a better yield over the long run, yet there will likewise be an immensely positive effect on the climate. This creates an environment where all the parties involved can thrive. Issues of extreme environmental damage leading to bigger devastating events can be prevented, which can help in bringing down natural and social dangers that might follow. There will likewise be a rise in ¸, which incorporates monetary services that coordinate ESG basis into their business and operations, which benefits both, the investors and the climate.
Better performance in ESG also corresponds with a reduction in downside risk, as evidenced, among other ways, by lower loan and credit default swap spreads and higher credit ratings. [1]
THE IMPLEMENTATION AND REGULATIONS REGARDING ESG IN INDIA
The implementation of ESG guidelines is still very new in India. Even though the investors and companies have started acknowledging its need, there is still a lack of implementation.
To formulate all this in a codified manner, the Ministry of Corporate Affairs announced the Voluntary Guidelines on Corporate Social Responsibility which became the “National Voluntary Guidelines” (NVG) on Corporate Social Responsibility (CSR) in 2011. The guidelines consisted of a total of 9 principles that discussed the Long-Term Sustainable Value of the Indian companies. Using these guidelines, the company can predict the several environmental and social risks that it might face in the future. Such information is then shared with the investors so that the investment decisions are made keeping in mind such risks and also helps them focus on finding ways to mitigate them. The guidelines being a voluntary approach, lack adequate adherence to them. In order to tackle this, SEBI in 2012 transformed this voluntariness into a compulsory mandate. It demanded for the top 100 listed businesses based on market capitalization to release a Business Responsibility Report. The threshold eventually included the top 500 companies to ensure maximum compliance with the scheme. To make the system more transparent, an integrated reporting mechanism was established by SEBI that provided all the necessary information to the stakeholders regarding the company’s strategy, governance and performance.
Another approach that was implemented was the requirement to issue Green Debt Securities under Section 11(1) of the Securities and Exchange Board of India Act, 1992. Green debt securities, commonly referred to as green bonds, are debt instruments intended to finance environmentally friendly projects in areas such as renewable and sustainable energy, low carbon transport modes, sustainable land use, water and waste management, climate change adaptation, energy efficiency, biodiversity conservation, etc. The purpose of this policy is dual-faceted as-
- Firstly, Green bonds are a good approach for an issuer to prove that it is environmentally conscious, which can assist to improve the issuer’s reputation. It demonstrates the issuer’s dedication to the advancement and viability of the environment.
- Secondly, A dedicated worldwide pool of funds has been set out specifically for investments in green ventures. The primary focus of such funding are the environmental, social, and governance (ESG) components of the projects. Therefore, green bonds give an issuer access to these investors that they might not have access to otherwise.
Finally, the SEBI planned to replace the BRR in 2020 with the “Business Responsibility and Sustainability Report,” [2]which aims to persuade businesses to provide information on not just their financial compliance, but also the social and environmental effects of their operations. The requirement was that the top 1000 corporations by revenue would voluntarily use a redesigned reporting format for the financial year 2020-21. After this, compliance is made mandatory.
The change in the applicability of such policies from a voluntary requirement to a mandatory one demonstrates that the narrative of ESG in India is being strengthened. An increase has also been seen in the focus on environmental issues in the company reports. The actual numbers showed that 87% of the reporting provisions dealt with environmental issues, while 35% dealt with social issues and 32% with governance issues. Key management of pollution, water, garbage, and other vital resources along with business operations were among the topics covered.
GENERAL ISSUES FACED DURING ESG IMPLEMENTATION
Just as ESG is an inseparable part of how a business is done, its individual elements are intertwined. For example, the environmental criteria overlaps with the governance of a company when the business is trying to bring into the market a newer product which would increase the firm’s profit margins but uses a lot of resources in its manufacturing. This associativity often leads to a few challenges in the implementation of ESG policies.
The Rapid policy changes in a short period of time have been effective but have also created some unpredictability, which has resulted in subpar and unclear communication reporting from businesses. Additionally, some businesses have begun to abuse sustainability reporting as a means to raise public awareness, which brings up the problem of Green Washing. It was noticed that companies were often seen conveying a false impression or providing misleading information about how their products are more environmentally sound. This was done to improve their public image and attract more customers as a result of which their profits would also increase. The main problem that has been picked up is the genuine consciousness/goal of the companies in implementing this approach. If their applicability is fuelled by just an increase in their profits and not an actual concern towards the environment or the public, there would always be room for misuse of such structures which would lead to the formation of a grey area about their effectiveness.
The environment also becomes a stakeholder in the operations of the company. According to the stakeholder theory of governance, the company owes a fiduciary duty to all of its stakeholders as they all have an interest in the firm’s actions and decisions. Their interests are to be considered before conducting business operations due to the impact that it may have on them. However, it is noticed that the environment is often overlooked as an important stakeholder and its interests are neglected. This results in an Agency problem. Here, the environment is the principle that is affected majorly by the actions of its agent which is the business. When an agency problem occurs, the business prioritises its own interests and directs all its actions in its favour as a result of this, the interest of the environment is disregarded. In a situation where any conflict occurs between the owners of the business and all of its stakeholders, including its creditors, employees, and clients, the environment is also impacted by the actions of the company in that scenario. Here, the correct approach would be to make sure that the company does not act opportunistically towards the other stakeholders that might be directly involved or more impacted. Their decisions should not come at the cost of the interest of the environment. To avoid irreversible harm, businesses should respect the environment as a crucial stakeholder and preserving it should be a priority to ensure the company’s long-term sustainability and profits.
HOW ESG REGULATIONS CAN BE IMPLEMENTED BETTER IN INDIA
- In India, a major problem is over-regulation. To do business a huge number of compliances and obligations need to be met. A way to motivate more companies to incorporate the ESG approach in their operations is through maintaining a record of all the companies that follow it, integrating them together and providing them with different prospectus requirements. Rather than creating new ESG regulations, which are the cause of over-regulation, they should be incorporated into the already existing laws. This would help to ensure that ESG companies do not need to undergo any unnecessary legal and compliance requirements. ESG companies indeed need to be put under a higher degree of scrutiny, but regulations need not be so diverse that it does not allow for any ESG firms to develop in the country. Incorporating it into the Companies Act, 2013, helps to ensure recognition of such companies while regulating them at the same time.
- One more step that should be taken is the formation of an ESG panel. In India, it is notable that despite the regulations being great on paper, ill-advised execution is predominant in all fields. This can lead to more damage than anything else. Thus, to battle this, a particular ESG board of trustees should be made which will guarantee legitimate execution of future ESG regulations. Apart from this, the panellists should be allocated extra allowance to offer to the organizations to follow ESG guidelines as it likewise urges organizations to move from bio-hazardable resources to cleaner and green resources. This not just aids in the working of the economy, but also the climate.
CONCLUSION
We can see that ESG guidelines are significant for the overall benefit of any organization. Incorporating ESG practices is essential for a company to fulfil the interests of all its stakeholders. Although India does not have sufficient ESG-related legislation, the approach has been gaining importance and recognition by Indian investors and companies. SEBI and other entities have also directed their operations towards establishing an organised system that will determine the responsibility and accountability of the businesses in this regard. The incorporation of the Business Responsibility and Sustainability Report by SEBI has majorly strengthened the regulatory framework. In order to make the operations more robust, the regulations should be incorporated by all companies, irrespective of their size or market capitalisation. Awareness needs to be spread regarding the threats that a company’s operations can have on the environment. This will motivate the companies to coordinate their activities in a way that they adhere to the ESG guidelines and aid in the holistic improvement of the environment as well as the long-term sustainability of the business
Studying and analysing the approach of The European Union (EU) in this regard will also help India in the successful application of such guidelines as the EU was one of the first to recognise the importance of ESG and take steps to incorporate it into its legislation [3]and create a difference in how the business operates.
[1] Umakanth Varrottil, Environmental and Social Reporting by Indian Companies (2019), https://archives.nseindia.com/research/content/QB_January_2019.pdf (last visited September, 2022).
[2] SEBI | Integrated Reporting by Listed Entities, Sebi.gov.in (2017), https://www.sebi.gov.in/legal/circulars/feb-2017/integrated-reporting-by-listed-entities_34136.html (last visited September, 2022).
[3] European Comission, Sustainable finance: Commission’s Action Plan for a greener and cleaner economy (2018), https://ec.europa.eu/commission/presscorner/detail/en/IP_18_1404 (last visited September 2022)
About the Author: Sonakshi Arora is a fourth year law student at Symbiosis Law School. With a knack of continuous learning and enhancing her knowledge. Her experience encompasses different areas of law including Mergers and Acquisitions, Intellectual Property Laws, Commercial laws etc. Her focus through Legal writing is to make it easier for the reader to understand legal concepts and at the same time increase her knowledge on different topics.