Will ESG investing become the new normal?
Introduction:
Covid 19 has disrupted the lives of many, from -- rich to poor -- developing to developed economies. As the pandemic intensifies, more & more companies are under scrutiny for their decisions that will affect their employees, vendors, customers, society and other stakeholders. Further, with GDP growth across the world going down to "sub zero", the focus now for the companies is on having a sustainable business continuity plan rather than just focusing on financial profits.
Should we have acted in a more responsible manner? and isn't there a need for greater accountability (in the way we function) towards the environment, society and in the way we govern? These have become the key themes in every human mind.
Thus, in such a scenario, when the non-financial parameters like climate change, sustainable farming / mining, privacy & data security, health and safety of employees, greater regulatory security are the issues that have come to the fore and are seriously under consideration by the corporates and the Governments across the world -- the questions that cross my mind are: Can the same focus of sustainability be replicated in the way we invest? Is it possible to look for investments beyond just economic returns?
ESG investing -- The Concept:
The acronym ESG stands for Environment, Social and Governance and ESG investing follows the criteria for investing in a socially conscious manner which is an amalgamation between -- economic returns, social good, influence and impact i.e. a balance between financial and non-financial parameters (rather than pure financial returns in traditional investments) of a company and brings in an aspect of being a responsible investor.
The concept of ESG investing is founded on the view that, the effective management of environmental, social and governance (ESG) issues is not only the right thing to do, but is also fundamental in creating long-term value. Responsible investors believe that companies that are successful in avoiding ESG risks while capturing ESG opportunities will outperform over the longer term.
Typical ESG risks encompass the following issues:
Environmental issues include pollution of land, air and water, eco-efficiency, waste management, natural resource scarcity and climate change.
Social issues encompass the health and safety, labour conditions and human rights of employees and those in supply chains. It also includes treating customers and communities fairly.
Governance in this context is generally held to encompass the governance of environmental and social issue management and issues related to business ethics and transparency.
Origin & History of ESG Investing:
Investing responsibly dates back as far as investing itself, when the Methodists and religious heads clearly laid out guidelines for their followers as to the types of companies they should invest in -- the best example being Shariah compliant investment funds.
In the modern times, the concept of responsible investing became more formalised with the advent of the mutual fund industry in the 1960's. With the growth of the mutual fund industry (1970's to 2000's), the collective unit holders realised their power to control corporate behaviour and thus, the popular opinion for investing responsibly gained ground.
The birth of ESG investing dates back to 2004 when the then UN Secretary General Kofi Annan invited a group of 50 CEOs of major global financial institutions (representing 12 countries) to join the process for developing the Principles for Responsible Investing (PRI). These Principles are based on the notion that environmental, social and governance (ESG) issues, such as climate change and human rights, can affect the performance of investment portfolios positively and should therefore be considered alongside more traditional financial factors, so as investors properly fulfil their fiduciary duty. The term ESG investing was coined a year later (2005) with the launch of the report "Who cares Wins".
According to the 2018 Report (latest available) by Global Sustainable Investment Alliance (GSIA) -- total assets under management under ESG-based Investments globally were US$ 30.7 Tn. led by Europe (being pioneer in ESG Investing) with a share of 52.6% in total ESG investing followed by Australia / New Zealand @ 50.6%, Canada @ 37.8% and US @ 21.6%. Asia's share in ESG investing stands at 0.8% with India's share at a minuscule of 0.1%.
ESG Investing -- The Indian Context:
ESG based investing is a new concept and at a nascent stage in India. According to a report by GSIA (2018), about 41 global Environment & Social (E&S) funds have invested about US$ 15 bn in Indian equities. Another 95 Global socially responsible funds have invested in Indian companies, a total corpus of about US$ 25 bn.
ESG based stock indices debuted in 2012 and currently there are five stock indices listed on National Stock Exchange (NSE) and Bombay Stock Exchange (BSE):
The Indian mutual fund industry (quick to capitalise on ESG theme) has rolled out new funds for investors. Currently, there are three funds following the ESG investment strategy in India:
Further, the fund houses -- ICICI Prudential, DSP, Aditya Birla, Kotak Mutual Fund and BNP Paribas India have filed draft offer documents (for ESG-based funds) with SEBI and are awaiting approval.
ESG initiatives and reporting standards -- Indian corporates on a strong footing:
Among the corporates globally, The Global Reporting Initiative Sustainability Reporting Standards (GRI) is considered as the benchmark of highest standards for reporting the impact on the economy, environment and society by any organisation.
In India, sustainability practices & philanthropy have been carried out by major Indian corporates since ages (mostly as a custom), however there has not been any practice of formally reporting the same. In August 2012, India's securities regulator SEBI issued Business Responsibility Reporting (BRR) norms for the Top 100 listed entities (extended to include Top 500 listed corporates in 2015) thereby stipulating non-financial reporting by corporate India across economic, environmental & social factors. The reporting requirement is in line with the "National Voluntary Guidelines on Social, Environment & Economic Responsibilities of Business (NVG's) notified by the Ministry of Corporate Affairs, GOI, 2011.
ESG investing has found strong ground worldwide, particularly with the formulation of 17 Sustainable Development Goals (SDGs) in 2015 by the United Nations as a basis for achieving sustainable development. The common global minimum program under the SDG's (to be achieved by 2030) is an attempt to (a) raise the quality of life across the planet, (b) to limit the risks to the environment; and (c) to support a more equitable socio-economic system.
In India, Niti Aayog (Apex Planning Body of India) has fine tuned these SDG's according to the Indian realities and constructed a Sustainable Development Framework (SDF) for 2018-22 in sync with the UN SDGs.
Secondly, the Corporate Social Responsibility (CSR) Act passed under the Companies Act, 2013, wherein corporates falling under the criteria (Revenues > Rs. 1,000 crore; PAT > Rs. 5 crore; Net worth > Rs. 500 crore) have to compulsorily donate 2% of average of last 3 years profit towards CSR (Social Cause) is a major implementable tool for enhancing social cause by the corporate.
Many of the corporates have successfully blended SDG's objectives and CSR initiatives with their business strategy for meeting up with the Social (S) of the ESG compliance.
On the governance front, a lot of steps have been taken by the Indian government since the establishment of SEBI (1995) so as to bring in fair governance practices into play amongst corporates. Good amount of focus has been laid on corporate boards, auditor accountability, enhanced disclosures and shareholder involvement in key decision-making. The landmark development with regards to corporate governance has been the introduction of Companies Act 2013 (established stringent requirements of Independent Directors). Further, committee reports like the Whistle Blower mechanism; insolvency and bankruptcy code; adoption of Ind-AS (India-Accounting Standards providing structural shift in reporting norms to global standards) -- have enhanced the corporate governance standards in India.
The Government has formulated many regulations and offered incentives so as to bring in the systems and compliance on the environmental front be it -- the introduction of Bharat Stage VI Standards (pollution emissions); Fame II scheme for the adoption of Electric Vehicles; Urea subsidy; renewable energy subsidies; Paris Agreement among others.
Thus, good progress has been made by the Government of India on the legislation and policy front for the promotion of ESG compliance and practice amongst the Indian corporates.
Conclusion:
Thus, we see
ESG investing typically moves from a predominantly profit-only motive towards the one that is more responsible and sustainable thus capable of averting risks & providing long-term returns.
ESG investing does provide a great opportunity for value creation viz. clean energy, green environment, healthy & safe working conditions, happy employees & community, transparent and ethical business dealings resulting in improved productivity and increased brand loyalty.
Investments, traditionally, have always been a trade-off between minimising risks & maximising returns. However, investing in ESG conscious companies additionally provides longevity & sustainability to the investment and life in general.
Further, ESG investing has established it's presence in India with three domestic mutual funds already operational and more funds awaiting SEBI approval.
Thus, having experienced a prolonged lockdown (a centenarian phenomenon experienced the world over), where discussions hover around bringing in sustainability to every aspect of human life -- a question, I leave for my readers, -- Will ESG investing become the new normal?
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