Getting the ESG framework right

Financial Express, January 4, 2023

By Pradeep S Mehta & Tanya Goyal

As we look beyond 2022, the need to disclose and quantify social risks as part of any Environmental, Social, and Governance (ESG) framework is becoming increasingly important. Given the social inequities and the pressing need for an equitable transition to a more sustainable economy, companies must quantify the ‘S’, i.e. , social in their ESG approaches. However, this cannot be achieved in isolation. Companies must evaluate their roles to take the movement ahead.

Certain big and medium-sized companies in the supply chain will help by requiring MSMEs to follow the path and thus become a part of the ESG movement which would help benefit people, the planet, and profits.

Social demands

Growing awareness of ESG factors and their importance to business sustainability is growing in India. This can help promote collaboration at policy and organisational levels to bring corporate goals and social demands together. However, a common phenomenon seen among organisations is to consider Corporate Social Responsibility (CSR) as part of their ESG acts. However, ESG is a more comprehensive concept and includes, but is not limited to, CSR activities. Therefore, companies should differentiate their CSR and ESG approaches to attain social goals.

High reporting cost

Another general perception is the high cost of ESG reporting, so companies shy away from it. In the study conducted by Singapore-headquartered bank DBS and Bloomberg Media Studios, it was noted that around 92% of SMEs are willing to focus on sustainable models as they form part of global supply chains. The problem is the cost of the deployment.

MSCI Inc., a global financial and portfolio analysis tool provider, conducted a four-year study on this issue. The study found that companies with high ESG scores experience lower debt, equity and capital costs than those with poor ESG scores. It is proven that an effective ESG programme can boost employee productivity, decrease the need for regulatory action, strengthen a company’s reputation, and encourage long-term sustainable growth.

Developed and developing economies

ESG is criticised in developing economies for imposing unrealistic criteria on businesses that are not ready, which explains fewer disclosures. A company must follow local legislation for ESG reporting; however, meeting global requirements for excellence might be difficult. All participants in the ESG ecosystem must work together to create a normative reporting environment that ensures transparency and reliability. However, the reporting framework must be different for developed and developing economies, and for small and large companies. Companies may need more resources to present disclosure acceptable to investors.

Human capital transformation

Conscientious organisations must value and prioritise its development and the community to promote social good in society at large. This criterion examines how well a corporation interacts with its community, customers, and business partners beyond commercial activities. For instance, rising social consciousness leads to more consumer boycotts, motivating businesses to emphasise their social obligations and good corporate governance, like eliminating toxic corporate culture and enhancing diversity, inclusion, and equity. However, a recent NSE study, proves that firms forget social parameters. This reiterates the need to strengthen social reporting standards in a country suffering from a lack of normative social indicators and difficulty in social impact measurement.

Investors’ culture for ESG framework

Companies have been unwilling to share information, such as policies on preventing human rights violations in supply chains, unless required by regulations or under intense investor pressure. There is a shift in investors’ culture as they continue to prioritise ESG issues. Regulators are also working to impose ESG disclosure requirements, but the fundamental problem is the low number of corporate declarations on social issues. Financial institutions must consider screening borrowers based on how sustainable their plan is .

Social indicators

Social indicators are agreed to be about the rights of stakeholders, including the company’s ethical treatment of its workers, clients, suppliers, and the general public. It also includes investing in human capital formation. Even though evaluating social impact has undoubtedly been challenging, it is not true to say that social issues are incredibly abstract.

Profit and production are important aspects of a company’s social impact evaluation. However, the company’s portfolio reflects its beliefs and moral principles, as they prioritise “S” in sustainable investing.

Modern business development and profit-making prioritise sustainable approaches, including actively managed funds that use ESG criteria as collateral. This has been reflected in the sharp rise in ESG-funds’ AUM in India, which have grown exponentially from $283.5 million (`2,268 crore) in March 2019 to $1.5billion (`12,447 crore) in March 2022. However, only one-fifth of the 586 Indian enterprises across sectors have released their sustainability reports.

Giving back to society and protecting the environment while paving the way for a sustainable future is a respectable idea. Every investment must contribute and act responsibly toward society regardless of size. A solid commitment to ESG values will benefit businesses, society, and the economy. The companies forming part of the supply chains must walk together.

This article has been written as part of the GrowJobs-II Project supported by the Ford Foundation and The authors work for CUTS International.

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