This article has been written by Abhinandan Sah pursuing a Personal Branding Program for Corporate Leaders from Skill Arbitrage.
This article has been edited and published by Shashwat Kaushik.
Table of Contents
Introduction
Bharat is set to become a world power in the coming decades; it’s already a leader in its various domains. On many platforms, it has been accepted as an unbiased entity regarding world policy. This has shown a remarkable increase in acceptance of Indian leadership. A country with the highest youth power should have a responsibility towards the environment, social, and governance. With a view of sustainability, Bharat introduced ESG concepts for better transparency across sectors.
Background
India has recently surpassed China in terms of population, becoming the most populous country in the world. This significant milestone brings forth imperative responsibilities for the nation to prioritise its environmental policies and ensure a sustainable future. It is paramount for India to adopt honest and proactive measures to address the challenges posed by its growing population.
The nation has a fundamental duty to provide its citizens with a better and healthier life. This entails implementing inclusive growth strategies across various sectors, encompassing social practices and policies. Creating job opportunities in all sectors is crucial to fostering economic growth and ensuring the well-being of the population.
Governance plays a vital role in shaping the trajectory of a nation. It is a process through which corporations and institutions maintain transparency and accountability. Ethical conduct within organisations is essential for the benefit of society as a whole. In a competitive global environment, it is imperative for organisations to value their human resources and prioritise necessary policies.
Considering these factors, the introduction of the ESG (Environmental, Social, and Governance) rating mechanism becomes imperative. ESG ratings evaluate companies based on their environmental, social, and governance practices. This mechanism encourages organizations to adopt sustainable and responsible business practices. By incorporating ESG factors into investment decisions, investors can contribute to a more sustainable future while generating long-term value.
The ESG rating mechanism aligns with India’s commitment to sustainable development and inclusive growth. By integrating ESG principles into policy-making and corporate decision-making, India can address the challenges of rapid population growth and pave the way for a prosperous and environmentally conscious society.
Timeline of ESG implementation
| 1990 | 2000 | 2011 | 2013 | 2023 |
| Globe started talking about ESG principles. | Bharat started advocacy of ESG principles. | MCA (Ministry of Corporate Affairs) released voluntary guidelines on ESG responsibilities. | Companies Act 2013, making CSR mandatory, has solidified the concepts of ESG. | SEBI Released Master Circular for ESG ratings provider. |
Elements of ESG
| Environment | Energy: Efficient use of energyWater pollution should be checked by the entities (zero liquid discharge).Waste management: Producers response to their own waste generatedLan and use Biodiversity: It should be according to the rules if operational activities are in places like the national parks, biosphere reserve sites, and other ecologically sensitive areas. |
| Environment and Social | The amount spent on CSR should be as per the rules specified by the Ministry of Corporate Affairs from time to time. |
| Social | Inclusive developmentJob creation in smaller towns.Percentage of material purchased from MSME.DiversityGender equality in wages and salary.Job creation and a better environment for differently-abled persons. |
| Governance | GovernanceTo disclose the against votes in appointing an independent director.Related party transactionTo disclose the against votes in non-promoter shareholders RPT.Purchases, sales, loans, advances, investments.RoyaltyRoyalty payment (if it increases that PBT income) must be disclosed. |
ESG regulation
ESG is not regulated by a single statute.
- ESG is regulated by the Companies Act, 2013.
- SEBI Regulations.
- CRA (Credit Rating Agency) Act.
- ESG is also regulated by other acts of environment, governance, and many more.
ERP (ESG rating provider)
- ESG Rating Provider is controlled by SEBI (Credit Rating Agency) Regulations, 1999 (Amended 4th July, 2023)
- SEBI Intermediary Portal https://siportal.sebi.gov.in/ is used for registration, cancellation, and approval of ERP.
- ERP should apply on the intermediary portal with some declarations, which are as follows:
- Shareholding pattern of the ERP.
- Information about past applications, which was not granted by SEBI.
- Any action pending for not following SEBI guidelines and its correction course taken.
- Investor complaints, if any.
- Details of litigation.
ERP type and its business models
| Subscriber pays | Where ERP derives its revenue directly through banksInsurance companiesPension fundsorThe Rated entity itself |
| Issuer pays | Where ERP gets its revenue through the Rated entity itself. |
Governance of ERP
The ESG rating provider (ERP) must be an unbiased institution. It cannot be a single person, and it must be registered as per the Companies Act, 2013. The board should constitute as follows-
- There should be a total of 1/3rd independent directors if the chairman is non-executive.
- If the chairman is an executive, then half the board should be independent directors.
- MD/CEO who has business responsibility will not interfere in ESG Ratings.
- Board should constitute
- ESG Rating Sub-Committee
- Nomination and Remuneration Committee
- The Rating Committee should report to the Chief Ratings Officer (CRO).
- The Chief Rating Officer (CRO) should report to the ESG Rating sub-committee.
- The nomination and remuneration committee must be chaired by an independent director.
Ratings parameter
The rating parameter must contain the following:
- New ratings
- Upgrades
- Downgrades
- Changes assigned post request/review
- Ratings after request of review/appeal by issuer
- Ratings that have undergone revision after request
- Ratings withdrawn
- Ratings distribution as of 31st March
- 100-90
- 89-80
- 79-70
- 69-60
- 59-50
- 49-40
- 39-30
- 29-20
- 19-10
- 9-0
- ESG score of 0-50 is considered poor, 51-69 is average, and 70 and more is considered good.
Uses of ESG ratings
- On the basis of these ratings, an investor can assess the risk of investing in the companies with the given ratings.
- An investor can make an informed decision based on ESG ratings in a meeting of shareholders.
- Investors with a sustainability mindset or who want to invest in a company with longer and better sustainability can opt for ESG ratings.
- Higher ESG ratings give comfort to financial institutions while giving credit to the companies.
- ESG Criteria can be used to evaluate governments, companies, or financial product providers with regard to three aspects of the environment (e.g., protection of resources and species), social issues (e.g., working conditions and safety), and governance (e.g., protection against exploitation or corruption).
- ESG Ratings mandate that corporations adopt better policies regarding transparency, which leads to better resource efficiency, cost savings, and better positioning in changing market conditions.
- It helps investors understand the risk management abilities of the management of the companies.
- If a company policy is towards net zero carbon emissions, such claims can be easily made through ESG metrics data backup.
- Human, social, economic, and environmental are the four pillars of ESG.
- ESG aims to cover all non-financial risks and opportunities in day-to-day activities.
- Institutional investors use ESG ratings for risk management and long-term performance objectives.
- Considering ESG factors, companies can mitigate potential risk, attract investors, reduce costs, and build a positive reputation.
- Investors believe that companies that perform well on ESG are less risky.
- Placing ESG and sustainability as a core business strategies offers a wide range of benefits that pay significant dividends down the line.
- Ethical issues are less in institutes with better ESG scores, making them more sustainable than those with lower ESG scores.
- Good ESG data is a better way to convince new customers, as good ESG data means a long-term and sustainable model of business.
- One of the factors of ESG is less waste generation; it directly leads to the maximum output from the input resources.
ESG ratings methodology
First, the ESG Rating Provider (ERP) gives weight to the three sections of ESG, i.e., Environment, Social, and Governance.
For instances:
Assume a rating agency gives the environment a weightage of 40%, social 30% and governance 30%.
And in its evaluation, if a company obtains 70 points out of 100 in environment, 80 points out of 100 in social, and 90 points out of 100 in governance.
Then its ratings will be (0.4*70+0.3*80+0.3*90)=(28+24+27)=79
So the ESG Score / Ratings of the company is = 79
Each rating agency has its own methodology for giving weightage to ESG, so the ratings may vary from ERP to ERP for the same company.
Challenges
Environmental, Social, and Governance (ESG) ratings have become increasingly important in evaluating the sustainability and responsibility of companies. SEBI’s mandate for all entities to disclose their ESG ratings aims to provide transparency and accountability in corporate governance. However, when it comes to coal and petroleum companies, the application of ESG ratings presents unique challenges.
Coal and petroleum are essential energy sources that play a crucial role in the development of nations. These industries often have lower ESG scores due to the inherent environmental impact of their operations, such as carbon emissions and pollution. ERPs (Enterprise Resource Planning) systems, which are used by companies to manage their operations and resources, must carefully consider the fundamental need for coal and petroleum in balancing sustainable practices with economic growth.
One challenge lies in reconciling the environmental concerns associated with coal and petroleum extraction and production with the socio-economic benefits they provide. These industries create jobs, support local economies, and contribute to energy security. ERPs must enable companies to track and report on their ESG performance while also highlighting the positive social and economic impacts of their operations.
Another challenge is the need for ERPs to capture and analyse data related to coal and petroleum’s environmental footprint. This includes monitoring carbon emissions, water usage, and waste management practices. ERPs must provide comprehensive reporting capabilities to help companies understand their environmental impact and identify opportunities for improvement.
Furthermore, ERPs should facilitate collaboration between coal and petroleum companies and external stakeholders, such as environmental organisations and regulatory bodies. This collaboration is vital for addressing ESG concerns, sharing best practices, and promoting sustainable development. ERPs should provide platforms for data sharing, communication, and stakeholder engagement.
By addressing these challenges, ERPs can empower coal and petroleum companies to operate more sustainably while fulfilling their critical role in meeting society’s energy needs. ERPs can also support the broader ESG reporting requirements mandated by SEBI, ensuring that companies provide transparent and comprehensive information about their environmental, social, and governance practices.
Suggestions for improving ESG rating transparency and awareness in India
1. Uniform ESG rating scale
- The Securities and Exchange Board of India (SEBI) has established a uniform ESG rating scale of 0-100, which provides a consistent and comparable framework for evaluating companies’ ESG performance. This uniform scale ensures that investors can easily understand and compare the ESG ratings of different companies, making it easier for them to make informed investment decisions.
2. Disclosure of ESG ratings to retail investors
- ESG ratings should be disclosed to retail investors in equity markets. This information is crucial for long-term investors as it can significantly impact the value of their investments. By providing retail investors with access to ESG ratings, they can make more informed decisions about which companies to invest in, considering both financial and ESG factors.
3. Declaration of ESG ratings during IPOs
- ESG ratings should be declared at the time of initial public offerings (IPOs). This will allow potential investors to assess the ESG performance of a company before making an investment decision. Disclosing ESG ratings during IPOs will also encourage companies to prioritise ESG practices from the early stages of their operations.
4. Display of ESG ratings on company websites
- Each company should prominently display its ESG ratings on its homepage. This will make it easier for investors, customers, and other stakeholders to quickly access and review a company’s ESG performance. Displaying ESG ratings on company websites also demonstrates a commitment to transparency and accountability.
5. Investor awareness programs on ESG ratings
- There is a need to raise awareness among investors about ESG ratings and their importance. SEBI can play a crucial role in this by conducting educational programs, workshops, and seminars to inform investors about ESG metrics and their potential impact on investment decisions. By enhancing investor awareness, SEBI can encourage more informed and sustainable investing practices.
6. Integration of ESG ratings into investment strategies
- Asset managers and institutional investors should incorporate ESG ratings into their investment strategies. This will encourage companies to improve their ESG performance to attract investment from socially responsible investors. Integrating ESG ratings into investment strategies can also mitigate financial risks associated with environmental, social, and governance issues.
These suggestions, if implemented effectively, can significantly enhance the transparency and awareness of ESG ratings in India. They will empower investors to make more informed investment decisions, promote sustainable business practices, and drive positive change towards a more sustainable and responsible economy.
Conclusion
ESG Ratings are rightly adhered to by Indian governments and effectively implemented as needed. This initiative has come at the right time now and should be more stabilised through rigorous monitoring. Through this rating system, loopholes and corruption in obtaining environmental clearance will end, as companies themselves will lead to more environmentally friendly decisions. Through this system, companies will expand in rural and small towns to adhere to job creation in small cities. Equal pay for equal work for both men and women will benefit women’s empowerment. Corruption and redtapism will be watered down through transparent governance mechanisms.
References
- https://government.economictimes.indiatimes.com/blog/emergence-of-esg-making-india-a-formidable-force-in-the-world-economy/109642306#:~:text=and%20the%20planet.-,ESG%20provides%20a%20way%20to%20assess%20risks%20like%20climate%20change,has%20been%20taking%20place%20rapidly.
- https://www.sebi.gov.in/legal/master-circulars/jul-2023/master-circular-for-esg-rating-providers-erps-_73856.html
- https://www.sebi.gov.in/legal/regulations/jan-2023/securities-and-exchange-board-of-india-credit-rating-agencies-regulations-1999-last-amended-on-january-17-2023-_68140.html
- https://www.investopedia.com/company-esg-score-7480372#:~:text=Environmental%2C%20social%2C%20and%20governance%20
- https://checksammy.com/blog/esg-score-meaning-breaking-down-the-calculation/#:~:text=These%20scores%20are%20calculated%20based,and%20other%20climate%20change%20impacts.
