How evolving ESG disclosure rules are altering investment dynamics in India

In recent years, the integration of environmental, social, and governance (ESG) factors into the investment management process has drawn increasing attention from both regulators and investors. This attention is the result of the growing recognition of the impact that material ESG factors have on the long-term prospects and sustainability of a business.

An increasing number of investors accept that an evaluation of an investment opportunity (whether equity or fixed income) is not complete without proper appreciation and analysis of these factors.

In a world in which commercial operations are increasingly threatened by extreme weather events, natural disasters, damage to reputation, and stakeholder relationships, the consideration of material ESG factors is not only logical but also essential for the investment management industry.

One obstacle for ESG integration is obtaining reliable data. Investors need ready access to high-quality, comparable, and relevant ESG information. Issuers have been under increasing pressure from investors, regulators, and stock exchanges to report more ESG information.

Much progress has been made in this area, but there is still some way to go.

And this is true in India

The ESG concept is picking up in India gradually. This year alone, two investment firms — Avendus and Quantum Advisors with three former Tata group employees — launched a $1 billion ESG fund in India.

Last year, Kotak Mutual fund became the fifth Indian investment management firm to sign the UN-supported Principles for Responsible Investment (PRI), joining a global network of investors that attempts to integrate ESG practices into investment practices. SBI Funds Management renamed its Magnum Equity Fund as Magnum Equity ESG Fund, a thematic fund investing in companies that follow the ESG norms.

What is driving these changes? Fund managers know that the integration of ESG factors allows for greater insight into how issuers approach the subject of sustainability. Research shows that a company that pays attention to relevant ESG factors and manages them well delivers better corporate financial performance.

It is not all about risk management, however: investors who can identify those companies that are at the forefront of sustainability, say, by delivering solutions to some of the common issues afflicting today’s world, may find additional alpha.

A look at ESG disclosure in India

In the past two decades, all major Asia-Pacific markets have taken steps toward mandating or encouraging disclosures in some or all aspects of ESG.

In India, the initial focus has been on getting larger companies to comply with these rules. Because they are deemed to have more resources, they are expected to provide leadership.

In 2009, India’s Ministry of Corporate Affairs published Corporate Social Responsibility Voluntary Guidelines, recommending that all businesses formulate a corporate social responsibility (CSR) policy. Two years later, the guidelines were superseded by the expanded and more detailed “National Voluntary Guidelines on Social, Environmental, and Economic Responsibilities of Business.”

In 2012, the Securities and Exchange Board of India (Sebi) issued a circular that made it mandatory for the largest 100 listed companies to publish an annual business responsibility report. This requirement was expanded to the 500 largest companies in Sebi’s Listing Obligations and Disclosure Requirements Regulations 2015.

The business responsibility report required companies implementing the core nine principles — ethics transparency and accountability, product life-cycle sustainability, employee well-being, stakeholder engagement, human rights, environment, policy advocacy, inclusive growth, and customer value — as well as compliance to spend 2% of its average net profit over the past three years on CSR initiatives.

In 2018, the Bombay Stock Exchange published a guidance document on ESG disclosures, a more modern and comprehensive set of voluntary ESG reporting recommendations, informed by global sustainability reporting frameworks. It underscored the importance of ESG disclosures to investors and provided 33 specific issues and metrics on which companies should focus.

Although CSR reporting in India is mandatory for the 500 largest companies, ESG reporting is still only voluntary for others. This leaves investors and the investment industry at a disadvantage when analyzing the full opportunities or risks embedded in a firm’s strategy. But we believe that pressure from investors will prompt companies to improve continuously.

Recommendations for Future Progress

As regulators and stock exchanges are driving changes in reporting and disclosures, there is, nevertheless, room for improvement in terms of quality. More importantly, the value proposition of ESG disclosures needs to be better articulated to motivate companies and boards to make improvements in this area and not to treat it merely as a box-ticking exercise.

Each stakeholder group has a distinct role to play in maintaining momentum and improving the quality of reporting.

It will be critical for corporations to educate their boards and senior executives to more fully integrate and report on how ESG aligns with the company’s strategic outlook, risk management framework, and corporate accountability, so that they can steer the company accordingly.

It also is important to encourage listed companies to upgrade the quality and consistency of ESG information, including more details on what is material ESG information and how this may affect valuation and future corporate performance.

Information is a two-way street: investors also should communicate to issuers what ESG information they would like to see and how that would affect an issuer’s valuation. This will ensure future improvements.

There may not be a one-size-fits-all approach in ESG-related information, but further refinement and understanding of such disclosures will improve their quality, consistency, and comparability.

Image Credit @ Getty Images/Witthaya Prasongsin