The importance of ESG in a business transformation strategy

For decades, corporates have talked about interlinked goals promoting people, planet and profits but rarely found the opportunity or will to walk the talk. When corporate social responsibility (CSR) became a statutory obligation through the Companies Act 2013, the needle moved somewhat, but not quite enough.

All of that is poised to change, in part thanks to the recent sustainability reporting norms from the Securities and Exchange Board of India (Sebi) that mandate an environmental, social, and governance (ESG) overview. Of course, these norms apply to the top 1,000 listed companies by market capitalisation by FY2023 and the reporting will come under a new business responsibility and sustainability report (BRSR) format. According to Sebi, this will bring both sustainability reporting and financial reporting at par.

ESG Issues And Opportunities

Accordingly, companies must provide an overview of their material ESG risks and opportunities as well as the approach in mitigating or adapting to these risks along with financial implications. The ESG reflects a company’s commitment to include environmentally-conscious business practices in tandem with robust social responsibility and corporate governance.

In allowing companies time to adapt to the new norms, for FY2022, the BRSR reporting will be voluntary and turn mandatory from FY2023. However, Sebi encourages companies to be early adopters for being at the forefront of sustainability reporting. No doubt, as time goes by, these disclosure requirements will be refined to make them more effective and useful for investors and the broader financial community.

At the centre of boardroom discussions worldwide, the ESG is all about reimagining the possibilities and coming up with solutions to the most urgent issues linked to innovative business models, the planet, people and shared prosperity. Well managed, the ESG can act as a catalyst in capturing opportunities, managing risk by staying ahead of the vulnerability curve, and potentially generating business and financial outperformance.

The nudge from Sebi apart, the COVID-19 pandemic has reignited the mantra of ‘people, planet and profit’ with both investors and India Inc. Today, high ESG scores are emerging as a prerequisite for companies in attracting investor interest and funds. Globally, the ESG funds crossed $1 trillion in assets in 2020. In India, there is rising demand from asset managers seeking companies with high ESG scores for investment. The pandemic accelerated enterprise and digital disruptions, driving the focus towards resilient business models, and highlighting the criticality of sustainable operations.

Consequently, several ESG-dedicated funds were launched in 2020 in India while globally $152 billion of fresh funds flowed into ESG-labelled products, with their total assets crossing $1.6 trillion. Yet, ESG investing is easier said than done as asset managers need to deep dive in finding funds that suit their investment plans. Investors also need to be sensitive to the concept of ‘greenwashing’ where companies make some marginal adjustments to get high ESG scores without fundamentally changing their business practices.

Not surprisingly, a mismatch exists between the ESG survey sentiments and the ESG action. An Aegon poll indicated that 77 percent of survey respondents believed climate change was a critical risk to consider before investing. Barely 15 percent of these respondents admit they are following up their sentiments with active ESG investments.

Pledges And Rationale

Be that as it may, the ESG is bound to gain traction in the coming years — evident, as an example, from the ESG being part of the World Economic Forum’s 2021 Davos summit agenda. It’s no surprise that many companies and countries have made ambitious public pledges about achieving ‘Net Zero Carbon Emissions by 2050’.

As an example, Apple has committed to having a 100 percent carbon neutral supply chain by 2030. By the same year, Microsoft has committed to becoming carbon negative. There are more pledges from big names committing to carbon neutrality. Likewise, asset-heavy sectors are building momentum behind higher usage of renewable energy to lower their carbon footprint.

Nonetheless, one needs to wait and watch to ascertain how many of these pledges are fulfilled. To achieve these pledges it is going to be critical to have publicly disclosed intermediate targets against which performance can be measured.

Meanwhile, more than altruistic motives, it’s apparent there is pressure from diverse stakeholders to fulfil the ESG norms. Considering the circumstantial compulsions, corporates have been adopting an exploratory approach, viewing the ESG from a compliance, reporting and risk-mitigation mindset. Strategically, they intend to address and assuage the concerns of investors while tracking the ESG issues raised in the media, and responding in a politically-correct manner.

The time for reactive responses, however, has gone past. Corporate interests will be better served by deploying a proactive approach that is independent of media, regulatory, or societal prods. Indeed, it represents an opportunity to lay the groundwork for emerging as future-ready enterprises, and driving greater value creation by dovetailing the ESG goals with their digital transformation agenda.

In the interim, it is likely the ESG rationale may not cut ice with some influential shareholders. If that is the case, statistics can drive home the point faster. Worldwide, approximately $30 trillion — or one-third of all the professionally-managed assets — now come under the purview of the ESG criteria. This number is only going to increase significantly. From April to June 2020, more than $70 billion of investments went into ESG equity funds — surpassing annual inflows into non-ESG funds by a broad margin.

Undoubtedly, meeting the ESG objectives isn’t just common sense — it makes complete business sense from a long-term value creation perspective. Now that’s something stakeholders, shareholders, investors and companies won’t quibble with.