Home Corporate Governance An overview of ESG towards better corporate governance

An overview of ESG towards better corporate governance

April 8, 2024

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This article has been written by Pawan Kumar and Aman Kumar Pandey pursuing a Diploma in Corporate Litigation course from LawSikho.

This article has been edited and published by Shashwat Kaushik.

Introduction

Environmental, Social, and Governance (ESG) are the regulatory measures formulated to encourage business practices towards sustainability and responsibility. There are emerging environmental issues such as pollution, climate change, deforestation, waste management, etc. Social issues such as inequality, poverty, human rights abuses, and discrimination, while governance issues such as regulatory compliance, lack of transparency, corruption, and failure of corporate governance, show the need for the implementation of a robust mechanism like ESG in India, which is very significant for investors making an investment in companies that are really committed to considering these issues and have robust governance practices to address these issues and mitigate the potential risk associated with these issues.

In India, companies have started recognising the importance of aligning their operations and strategies with ESG principles. Talking about ESG reporting in India, it was initiated in 2009 by the Ministry of Corporate Affairs by issuing the Voluntary Guidelines on Corporate Social Responsibility (CSR). In this article, we will learn how the term “ESG” is different from the term “CSR,” the significance and implications of ESG in India, the provisions that primarily govern ESG regulation in India, ESG reporting and other nuances with respect to ESG.

ESG pillars

ESG frameworks have the following three pillars:

Environmental pillar

It deals with pollution, biodiversity loss, corporate climate policies, energy efficiency, greenhouse gas emissions, complying with environmental regulations, deforestation, waste and water management, etc.

Social pillar

It deals with working conditions, the company’s relationship with internal and external stakeholders, diversity in work culture, employees’ health and safety, employee engagement, etc.

Governance pillar

It deals with ensuring that a company uses transparent and accurate methods of accounting, is accountable to shareholders, pursues integrity and diversity while selecting their leaders, deals with how the leader interacts with and responds to all the stakeholders of the company, prevents corruption, etc.

Differences between ESG and CSR

The key differences between ESG and CSR are as follows:

Scope: ESG is a broader concept that encompasses social, environmental, and governance factors, while CSR primarily focuses on the social and environmental impact of a company’s operations.
Integration: ESG factors are increasingly being integrated into investment decisions, while CSR is less commonly used in this context.
Reporting: Many companies are voluntarily reporting on their ESG performance, while CSR reporting is less standardised and not as widely adopted.
Regulatory environment: ESG is becoming increasingly regulated, with many countries and jurisdictions implementing mandatory ESG reporting requirements. CSR, on the other hand, remains largely voluntary.
Stakeholder engagement: ESG emphasises stakeholder engagement and considers the interests of various stakeholders, such as shareholders, employees, customers, and the community. CSR, while also considering stakeholders, may not have the same level of engagement and focus on long-term value creation.
Long-term impact: ESG is often seen as a more comprehensive and long-term approach to sustainability, while CSR may be considered a more short-term and reactive approach.
ESG is driven by external factors like regulatory compliance for ESG reporting, whereas CSR is usually driven by the internal values of a company and its desire to become a better corporate citizen.
ESG factors are more quantitative in nature, whereas CSR initiatives are primarily qualitative.

It would not be wrong to say that CSR is the actions that a company takes to become socially responsible, whereas ESG can be considered a scoreboard that evaluates the impact of those actions taken by the company. In other words, CSR initiatives are about doing good to society, whereas ESG factors are about assessing and reporting the impact or the end result of that good deed. ESG and CSR both play a significant role for companies in the present world.

ESG regulatory environment in India

The Ministry of Corporate Affairs (MCA) and the Securities and Exchange Board of India (SEBI) play an important role in encouraging ESG integration and reporting into corporate practices in India. SEBI, as the chief regulatory authority for the Indian securities market, has taken various initiatives to encourage ESG compliance and reporting and made it mandatory for the top 1000 publicly listed companies.

Recognition of some ESG rating agencies by the Security and Exchange Board of India for scoring and verifying companies’ ESG disclosure helps to ensure transparency, reliability, and comparability of ESG data. Subsequently, this helps in gaining investor’s trust in the credibility and accuracy of ESG data.

MCA’s role in ESG integration and reporting

The Ministry of Corporate Affairs (MCA) plays a crucial role in promoting ESG integration and reporting in India. Through the Companies Act, 2013, the MCA has introduced several provisions that encourage companies to adopt ESG practices.

The Companies Act of 2013 in India has incorporated several provisions that emphasise and promote the integration of Environmental, Social, and Governance (ESG) considerations into corporate practices. These provisions are crucial in aligning business operations with sustainable development goals and fostering responsible corporate behavior.

Section 135 and Schedule VII

Section 135 mandates companies with a net worth of INR 500 crore or more, a turnover of INR 1000 crore or more, or a net profit of INR 5 crore or more to spend at least 2% of their average net profits over the preceding three years on Corporate Social Responsibility (CSR) activities. Schedule VII of the Act provides a list of CSR activities that fall within the ambit of ESG, such as promoting education, healthcare, and environmental sustainability initiatives.

Business responsibility reporting

The Act requires companies to include a Business Responsibility Report as part of their annual report, which encompasses ESG-related disclosures. This report must detail the company’s CSR initiatives, policies, and performance, providing stakeholders with transparency and accountability.

Board diversity

The Act mandates listed companies to have at least one woman director on their board, promoting gender diversity and inclusivity in corporate decision-making.

Stakeholder engagement

The Act emphasises the importance of stakeholder engagement, encouraging companies to engage with their stakeholders, including employees, customers, suppliers, and communities, to address ESG-related concerns and incorporate their perspectives into their strategies.

Sustainability reporting

While not explicitly mandated, the Securities and Exchange Board of India (SEBI), the capital markets regulator, has encouraged listed companies to adopt sustainability reporting frameworks, such as the Global Reporting Initiative (GRI), to enhance ESG disclosures and provide comprehensive information to investors and stakeholders.

Further, Section 134(3)(m) of the Companies Act 2013 (the Act) mandates a report by the company’s Board of Directors (BoD) to include details on energy conservation. Likewise, Section 166(2) of the Act imposes a duty on a director to act in good faith, to promote the objectives of the company for the benefit of its members, and in the best interests of the company, all the stakeholders (employees, shareholders, and community), and for the protection of the environment. Moreover, Section 149 of the Act mandates specific classes or classes of companies to have at least one female director, which shows a social element of ESG to encourage women’s participation in corporate decision-making. Section 177 of the Act mandates the BoD of every listed public company to form an Audit Committee, which shall consist of a minimum of three directors, wherein independent directors have a majority. Likewise, Section 178 of the Act mandates the BoD of every listed public company to form a Nomination and Remuneration Committee, which shall consist of three or more non-executive directors, out of which not less than a half shall be independent directors, which shows a governance element of ESG to promote better corporate governance practices in companies.

National Voluntary Guidelines on ESG Reporting

In 2021, the MCA released the National Voluntary Guidelines on ESG Reporting. These guidelines provide a comprehensive framework for companies to adopt ESG reporting practices. The guidelines cover various aspects of ESG reporting, including ESG performance indicators, disclosures, and reporting methodologies.

Investor relations

The MCA recognises the growing importance of ESG for investors. In recent years, there has been a significant increase in investor demand for ESG-compliant investments. To meet this demand, the MCA has taken steps to encourage companies to disclose ESG-related information.

Capacity building

The MCA is also working to build capacity among companies to adopt ESG reporting practices. The ministry has organised several training programmes and workshops for companies on ESG reporting. Additionally, the MCA has partnered with various organisations to develop resources and tools to assist companies with ESG reporting.

The MCA’s efforts to promote ESG integration and reporting are significant in several ways. First, they help to align India’s corporate sector with global best practices in ESG. Second, they provide investors with the information they need to make informed investment decisions. Third, they encourage companies to adopt sustainable practices that benefit both their stakeholders and the environment.

SEBI’s role in ESG integration and reporting

Integration of ESG into investment decisions

The Securities and Exchange Board of India (SEBI) has been proactive in promoting the integration of environmental, social, and governance (ESG) factors into investment decisions. Recognising the growing importance of ESG considerations in global financial markets, SEBI has taken several steps to encourage institutional investors to incorporate ESG factors into their investment processes.

In 2015, SEBI issued a circular on “Integration of Environmental, Social and Governance (ESG) Factors in Investment Decisions by Institutional Investors.” This circular urges asset management companies (AMCs) and mutual funds to consider ESG factors when making investment decisions. It emphasised that ESG factors can have a material impact on a company’s long-term performance and can help investors make more informed decisions.

In 2018, SEBI issued another circular on “ESG Reporting by Listed Entities.” This circular mandated the top 100 listed companies by market capitalization to report on ESG-related disclosures in their annual reports. This move was aimed at enhancing the transparency and comparability of ESG-related information for investors.

SEBI’s efforts have been instrumental in raising awareness about ESG investing among institutional investors in India. Many AMCs and mutual funds have developed ESG-focused investment strategies and products in response to SEBI’s guidelines.

The integration of ESG factors into investment decisions has several benefits. ESG factors can help investors:

Identify and manage risks: ESG factors can help investors identify and manage risks related to climate change, social unrest, and governance failures.
Generate long-term returns: Studies have shown that companies with strong ESG performance tend to outperform their peers in the long run.
Attract and retain investors: Investors are increasingly looking for investments that align with their values. By integrating ESG factors, institutional investors can attract and retain investors who are seeking sustainable and responsible investments.

SEBI’s initiatives have played a significant role in promoting ESG investing in India. As more investors adopt ESG-focused investment strategies, it is expected that ESG factors will become increasingly mainstream in the Indian capital markets.

ESG disclosure requirements

SEBI, through its Business Responsibility and Sustainability Reporting (BRSR) framework, requires listed companies to make ESG-related disclosures in their annual reports. These disclosures cover aspects such as environmental performance, social impact, and governance practices.

ESG reporting guidance

SEBI has also published guidance for companies on ESG reporting. The guidance provides detailed explanations of ESG reporting requirements, including industry-specific disclosures and best practices.

Collaborative efforts

Joint working group

MCA and SEBI have established a joint working group to enhance coordination in the area of ESG integration and reporting. This group aims to address challenges and develop strategies for promoting ESG reporting practices in India.

Adoption of global frameworks

Both MCA and SEBI recognise the importance of aligning with global ESG frameworks. They actively participate in international forums, such as the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB), to stay updated on emerging ESG reporting standards.

The regulations related to ESG are not only found in the Companies Act, 2013 and the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, but they also come under several legislations, which include the Environment (Protection) Act, 1986; Hazardous Waste (Management, Handling and Transboundary Movement) Rules, 2016; Water (Prevention and Control of Pollution) Act, 1974; Air (Prevention and Control of Pollution) Act, 1981; Factories Act, 1948; Prevention of Corruption Act, 1988; Prevention of Money Laundering Act, 2002; and several laws relating to the payment of minimum wage, health and safety, gratuity, bonus, welfare activities, etc.

Integration of SDG with ESG

The SDGs outline a set of 17 interrelated goals that were adopted by the members of the United Nations at the 2015 UN Summit and were implemented on January 1, 2016. It was adopted by the member states to achieve the goal by the year 2030 of providing the world with a better and more sustainable future for the coming generations.

SDGs and ESG are the two major frameworks that are responsible for driving businesses towards sustainable and accountable practices. Businesses can integrate their SDGs with their ESG strategies, as this integration will enhance the business’s reputation and attract more investors. The integration will also contribute by solving global problems and creating a better future for society.

India’s rank in achieving the Sustainable Development Goals has improved to 112^th in 2023 but it still remains at the bottom of the list. Aligning SDGs with ESG practices can help India improve its rank.

The integration of SDGs with ESG can be done by businesses by identifying and aligning the most relevant SDGs that fit with the core operation of the company and their practical implementation by the board of directors with the existing ESG strategy of the company.

SDGs and ESG can be considered two sides of the same coin and there are a lot of ways in which SDGs can be achieved by working on ESG strategies:

A company working with an ESG strategy to reduce carbon emissions and putting efforts into promoting renewable energy will also contribute to Clean Energy- SDG 7 and Climate Action- SDG 13.
Clean Water and Sanitation- SDG 6 can be achieved by implementing ESG strategies such as reducing water pollution, preserving water resources, and putting efforts into building a future where access to clean water can be provided to everyone by implementing sustainable water management practices.
A company can align decent work and economic Growth- SDG 8 with its ESG strategy and promote sustainable economic development by providing decent working conditions, fair wages and a safe working environment for its employees.
If the ESG strategy of an organisation works on reducing waste generation by minimising waste during their operations and by recycling or reusing the products, it will contribute towards Responsible Consumption and Production- SDG 12.

We can unlock the pathway for a sustainable future by aligning businesses with the global vision of the SDGs and ESG.

ESG reporting

Companies can use the ESG reporting framework to show that their business is sustainable and ethical in nature. The ESG frameworks provide a cohesive layout for evaluating the company’s environmental and social impact, and they also deal with the risks and opportunities involved in the business.

What is ESG reporting

ESG reporting can be defined as companies publishing their ESG reports every year to show the progress made towards their environmental, social and governance goals. The annual report consists of various ESG metrics to assess the performance of the company in the areas of environmental, social and governance by using both numerical and qualitative data. The report often outlines the company’s long-term ESG vision.

ESG reporting in India

Earlier in 2009, the MCA (Ministry of Corporate Affairs) introduced BRR (Business Responsibility Reporting), which was used as a framework for reporting ESG but because of its failure to provide comprehensive and relevant data, there was a requirement to refine it to meet the complexity of the ESG programme.

In 2021, BRSR (Business Responsibility and Sustainability Report) was introduced by SEBI. The reporting format was established on the basis of nine principles that were outlined in the NGRBC (National Guidelines for Responsible Business Conduct). Companies need to include the BRSR report in their annual report, which will readily be available on the company’s website, on stock exchanges and directly provided to the company’s shareholders. Non-compliance or failure to submit a BRSR report may lead to fines and penalties by the SEBI. The BRSR framework is built on nine principles outlined in the National Guidelines for Responsible Business Conduct (NGRBC). These principles provide guidance on various aspects of responsible business conduct, including respect for human rights, labour standards, environmental protection, and stakeholder engagement. By aligning their reporting with these principles, companies can demonstrate their commitment to responsible practices and ensure transparency in their operations.

The BRSR reporting format encompasses a wide range of disclosures, covering areas such as corporate governance, risk management, supply chain management, employee well-being, and community engagement. It requires companies to provide detailed information on their ESG initiatives, performance metrics, and targets. This comprehensive reporting format enables investors, consumers, and other stakeholders to assess a company’s sustainability efforts and make informed decisions based on their ESG commitments.

The introduction of the BRSR framework represents a significant step towards promoting responsible business practices and enhancing corporate transparency in India. It encourages companies to integrate sustainability into their core operations and contribute to achieving sustainable development goals. By embracing the principles outlined in the NGRBC, companies can foster a culture of responsible business conduct and positively impact society and the environment.

ESG challenges

Despite the numerous benefits of practicing ESG, companies are still facing a lot of challenges when implementing ESG practices effectively.

Adoption of ESG

Although India is witnessing a growing awareness of ESG practices, a lot of businesses in India are still facing a significant challenge in adopting ESG practices. In a survey conducted by Deloitte, it was found that only 27% of companies are effectively meeting the current ESG framework. In India, there is a limited supply of ESG professionals, which is not meeting up with the growing demand. Adopting ESG practices will not only lead a path towards a sustainable future but also improve the public image of the company.

Short-term focus

The biggest hurdle in implementing ESG practices in India is that most Indian companies are still attracted to fulfilling their financial goals while neglecting their long-term sustainability goals, as the businesses have not yet realised the value of implementing ESG practices in their operations.

Supply chain

A major challenge faced by the companies while aligning their operations with ESG lies in their supply chain, as the few partners who form a part of the chain are small businesses, and it becomes tedious work to make them understand the importance of sustainability and goals, as well as the necessary ESG data.

Criticism of ESG

Decline in popularity

Despite the growing popularity of ESG, the increasing number of greenwashing cases is potentially reducing its credibility and impact.

There’s been a decline in the investor’s interest in the ESG factor of the company, as there was a fall from 65% in 2021 to 53% in 2023 in the UK. In a survey that was conducted by Edelman, nearly 75% of institutional investors lack trust in the company’s ability to deliver on its ESG commitments.

Lower returns

While there is widespread support for ESG investing, certain studies show that there are not many financial advantages for both businesses and investors.

In a study held by the European Corporate Institute, it was found that the investment in businesses made by “responsible investors” was not able to improve their ESG scores and it even led to lower financial returns. Furthermore, critics argue that ESG investing may lead to portfolio underperformance. They contend that by focusing on ESG factors, investors may sacrifice financial returns, as ESG-compliant companies may not always be the most profitable. However, studies have shown mixed results on the relationship between ESG performance and financial performance, with some indicating a positive correlation and others finding no significant impact.

Additionally, some critics question the effectiveness of ESG investing in driving positive social and environmental change. They argue that while ESG investing may raise awareness and encourage companies to adopt more sustainable practices, its impact on systemic issues such as climate change and social inequality may be limited. They suggest that more comprehensive policy interventions and government regulations are necessary to address these challenges effectively.

Despite the criticisms, ESG investing continues to gain traction among investors who seek to align their portfolios with their values and contribute to a more sustainable future. As the field evolves, efforts are being made to address the challenges and improve the transparency, consistency, and impact of ESG investing.

Conclusion

Emerging environmental, social, and corporate governance issues show the need for the implementation of a robust mechanism like ESG. ESG consists of three important pillars, as the name suggests, including the environmental, social, and governance pillars to tackle respective issues. Companies in India have started recognising the importance of aligning their operations and strategies with ESG principles.

Regulatory bodies such as the Ministry of Corporate Affairs and the Securities and Exchange Board of India play an important role in promoting ESG integration and reporting into corporate practices in India. Despite the numerous benefits of practicing ESG, companies are still facing a lot of challenges when implementing ESG practices into their businesses. Although there is a growing popularity for ESG, the increasing number of greenwashing cases is potentially reducing the credibility and impact of ESG, and certain studies show that there are not many financial benefits for both businesses and investors. To tackle such issues as increasing greenwashing cases associated with ESG practices, comprehensive and more transparent reporting guidelines are needed.

Regulatory bodies can take capacity-building initiatives and organise training programmes to ensure businesses are equipped with the essential tools and knowledge. Through these training programmes, companies will know the significance of ESG adoptions and be able to effectively include these aspects in their reporting systems. Such small measures will form the foundation for fostering transparency, sustainability, and accountability in India’s corporate landscape.