By Rishi Agarwal
Investing based on the environmental, social and governance parameters of companies’ performance, or ESG investing, is still to take wing in India, but in the West, it is the subject of intense political debate even while it gains greater favour with investors.
ESG Investing Under Fire in the US
ESG investing currently faces an extraordinary shakedown in the US, branded a ‘woke mind virus’ as Republicans launch a protracted assault on the idea of socially responsible investing by companies, private equity and small investors. At least some roots of this anti-ESG movement are in plain old climate denialism, but some of it derives from the societal divides of our time—conservatives believe that liberal activists have gained unfettered sway over corporate America, and that their growth must be nipped. Some have called it prioritising social activism, at the cost of profits for shareholders.
India’s Growing ESG Landscape
In the Indian context, ESG investing is still in an embryonic stage, but is growing rapidly alongside a fattening dossier of ESG policies and regulations. The regime is still switching gears from voluntary to mandatory reporting of ESG practices, but already, asset management companies are invoking ESG norms in investment decisions; and there is a growing appetite for ESG-integrated assets among fund managers and prospective investors.
India’s ESG Ambitions
Indeed, India’s ambitious global commitments at COP 26 in Glasgow—net zero by 2070, cutting carbon emissions by 1 billion tonnes before 2030, growing renewable energy to 50% of the total by 2030—should provide a broad appraisal of how much more ESG integration we can envisage in investing.
India and China Leading in Sustainable Investing
Along with China, India enjoys the world’s highest potential for growth in sustainable investing, according to Standard Chartered’s Sustainable Banking Report 2022. Citing the two countries’ large populations and rising domestic wealth, the report said 40% of Indian investors want to direct their money towards addressing climate issues.
Challenges and Concerns in ESG Investing
Clearly, we have been presented with an opportunity. How do we now seize this potential, to direct financial investments towards decarbonising efforts in corporate India, and turn it into a genuinely meaningful endeavour, without triggering campaigns looking to label it as woke capitalism?
There are well-reasoned fears that as sustainability investing begins to wield some influence over capital markets, consequently impacting companies and others who are looking to raise capital, we might witness distorted and misleading portrayals of social responsibility. Companies could indulge in data manipulation to corner a larger share of the ESG-focused investment pie.
Simultaneously, we also face the prospect of ESG investing becoming another check-the-box practice, the very woke signalling that American conservatives are attacking it for.
An honest appraisal of ESG investing as we have begun practising it in India is in order.
Navigating the ESG Data Maze
Luckily, there is unanimity on the biggest challenges. Regulators, companies and investment professionals alike are trying to unravel the Gordian knot of ESG investing—data. Companies’ data on ESG matrices is neither standardised, nor consistently available, nor consistently verified. Methodologies and matrices lack any homogeneity.
Predicament of Standardization
Even with mandatory reporting on the anvil, how to standardise measurement and reporting of data continues to be a predicament.
Greenwashing and Data Reliability
Additionally, despite stern announcements of penal provisions against greenwashing, from investors’ viewpoint, the reliability of data cannot always be guaranteed because a fuzzy data ecosystem may enable companies to airbrush their ESG performance.
ESG as a Structured Endeavor
Yet, none of this goes to suggest that ESG investing is a performance sport. What Indian investors, and corporates, need is a structured approach, a step-by-step toolkit to steady the ship.
Here are five things regulators and companies must focus their energies on to ensure that ESG investing is right on the money.
- Standardisation: There is no short-cut here. Industry bodies and government agencies will have to work together to create a unified set of rules and norms on reporting ESG data and metrics. These should definitively address the data needs of multiple categories of stakeholders, including the regulator, ratings providers, index providers, asset managers, institutional investors, etc.
- Simplification: A complex web of multiple ESG ratings can be daunting—for companies, causing them to struggle with adhering to sustainability standards; and for stakeholders, whose assessment of companies’ social and environmental performance stumbles when different companies have different rating benchmarks. A simplified approach must include a concise set of two or three headline metrics for every sector. For example, the automobile sector could focus on every vehicle’s carbon footprint over its lifetime; the company’s transparency on supply chains, ethical sourcing, suppliers’ environmental performance; and a measure of the circularity of every vehicle, the ability to easily recycle, reuse parts that may already be built using renewables.
- Transparency: Much greater transparency and comprehensive disclosure requirements are needed, which will cover a broad range of ESG metrics, including sustainability risks, adverse sustainability impacts, etc. To tackle disparity in information availability on ESG performance, all financial market participants, fund managers, advisors, etc must also make comprehensive disclosures to investors.
- Harmonised rules for financial market participants and financial advisers on transparency with regard to the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes and the provision of sustainability-related information with respect to financial products.
- Technology: Wider education and advocacy on Artificial Intelligence (AI), natural language processing (NLP) and blockchain solutions that may hold the answers to ensure data availability, homogeneity and consistency.
Debating ESG Returns and Political Backlash
The jury is still out on whether evidence shows that high-performing ESG scores bring higher returns to investors than their peers, particularly over longer periods of time. The political backlash in the US against ESG investing is also more than a bump in the road, particularly with retirement funds and pension funds of fire-fighters, librarians, school-teachers, etc now being placed at the centre of the debate.
ESG Scores as Risk Analysis
Ultimately, however, an ESG score is a reflection of a risk analysis, considering likely or possible outcomes of a company’s performance on various parameters to make an assessment of potential return on investment.
Progress Towards Interoperability
The work of addressing the lack of interoperability of divergent methodologies and frameworks used to arrive at this score is well underway. Global non-profit IFRS, which works on financial reporting norms for a sustainable world, established the International Sustainability Standards Board (ISSB) at COP 26, which published a draft of a new set of standards in 2022, and a final document on June 26, 2023.
The Urgency of Action
This may well undergo more iterations, but in the years or decades that it takes us to establish perfect interoperability of different methodologies, scores and regulatory frameworks, the world can hardly wait to be gifted this perfect data. The climate crisis is ‘out of control’, the United Nations has said. We need to incentivise the ideal of investing in companies that are serious about their green transitions, today, and we have to recognise that the planet needs it regardless of its critics.
About the Author
Rishi Agarwal, Managing Director and Head Asia, FSG.
