Growing Importance of ESG | What is ESG Investing? (2024)

In today's world, investors are increasingly looking for ways to align their financial goals with their values. ESG investing has emerged as a popular strategy that allows individuals to invest in companies that prioritize environmental sustainability, social responsibility, and strong governance practices.

What is ESG Investing?

ESG stands for environmental, social, and governance. ESG investing involves evaluating companies based on these three factors to guide investment decisions. Investors seek out companies that demonstrate a commitment to sustainability, social justice, diversity, and responsible governance practices. By investing in ESG-focused companies, individuals aim to generate positive social and environmental impact alongside financial returns.

What are these three pillars?

Environmental: Environmental factors encompass a wide range of issues, including climate change, pollution, resource depletion, and biodiversity loss. ESG investors look for companies that prioritize environmental sustainability by adopting green technologies, reducing carbon emissions, managing waste responsibly, and conserving natural resources.

Social: Social factors focus on how companies interact with their employees, customers, communities, and other stakeholders. ESG investors seek out companies that promote fair labor practices, respect human rights, and foster diversity and inclusion.

Governance: Governance factors assess how companies are managed, including their leadership structures, executive compensation, shareholder rights, and transparency in financial reporting. ESG investors look for companies with strong corporate governance practices, independent boards of directors, and effective risk management systems.

The Growing Importance of ESG Factors

The increasing importance of ESG factors can be attributed to several factors.

• Firstly, there is a growing awareness of environmental issues, such as climate change, pollution, and resource depletion. Investors are becoming more conscious of the long-term risks associated with companies that do not prioritize sustainability.
• Secondly, social issues such as human rights, labor rights, and income inequality are gaining significant attention. Investors are recognizing that companies with responsible social practices are more likely to thrive in the long run.
• Lastly, governance practices play a crucial role in ensuring transparency, accountability, and ethical decision-making within an organization. Investors are placing greater emphasis on companies with robust governance structures.

Evolution of ESG Investing in India

India, with its long coastlines and large population, faces significant climate risks. Heat waves, flooding, and air pollution have become frequent issues. Climate change has impacted agriculture, water supply, and human health. To combat these risks, India aims to become a net-zero economy by 2070 and reduce carbon intensity by 45% by 2030. Achieving this requires major investments in decarbonization. Collaboration among industries, government, academia, and individuals is essential.

A major achievement was the launch of the "Measuring Stakeholder Capitalism" Framework at the World Economic Forum's Sustainable Development Impact Summit in September 2020. This framework, supported by the International Business Council (IBC) and developed with consulting firms, offers universal ESG metrics and disclosures for all companies.

In just six months, the number of ESG funds in India tripled from three in October 2020 to nine in February 2021. Major fund houses like SBI, ICICI, Kotak, Axis, and Aditya Birla have all launched their own ESG funds. These funds invest in stocks and bonds of companies that prioritize environmental, social, and governance factors. It's important to note that the investment portfolio includes more than just green business stocks.

There are many challenges with ESG investing in India

1. One of the main challenges is the lack of standardized ESG reporting frameworks. Different companies may use different metrics and methodologies to assess and report their ESG performance, making it challenging for investors to compare and evaluate companies effectively. This lack of standardization also hinders the integration of ESG factors into traditional financial analysis models.
2. Another challenge is the availability and quality of ESG data. Companies vary in their disclosure practices, with some providing comprehensive ESG information while others offer limited or vague disclosures. This inconsistency makes it difficult for investors to obtain accurate and reliable data for informed decision-making.

How ESG is an important component for Financing?

In today's rapidly changing business landscape, environmental, social, and governance (ESG) factors are becoming increasingly important for companies across all sectors. For financial institutions, integrating ESG into their business models is not only a strategic imperative but also a way to drive sustainable growth and create long-term value.

Banks can prioritize ESG by including it in their lending portfolios and offering tailored loans to companies committed to sustainability. This sends a strong signal to the corporate sector to adopt ESG practices.

Driving Operational Efficiencies: Banks in North America, like JP Morgan, Wells Fargo, and Bank of America, are prioritizing operational efficiency to incorporate ESG into their business models. They are taking steps to address climate change and environmental concerns, demonstrating their dedication to ESG themes.

ESG integration in banking requires a comprehensive approach: sustainable finance, operational efficiencies, and responsible investing. Prioritizing sustainable lending helps banks support ESG-focused companies and drive positive change. Operational efficiencies, like specialized teams and renewable energy partnerships, align banks' operations with ESG objectives. ESG factors are crucial for investors' decision-making, emphasizing environmental sustainability, social responsibility, and strong governance practices. ESG investing has challenges but offers benefits and aligns with investor values. As sustainability gains importance, ESG integration will become even more significant.

ESG Regulations in India:

SEBI has mandated several disclosures for companies in their BRSR reports. These requirements aim to enhance transparency and accountability in ESG practices. Some of the key disclosures include:

1. ESG Risks and Mitigation Strategy: Companies must disclose the ESG risks they face and highlight the strategies they have in place to mitigate these risks. They must also report on the financial implications of these risks.
2. Sustainability Goals and Performance: Companies are required to disclose their goals related to sustainability and report on their performance in achieving these goals.
3. Environment-related Disclosures: These disclosures include waste management practices, biodiversity conservation efforts, the quantum of waste generated, and greenhouse gas (GHG) emissions.
4. Workforce-related Disclosures: Companies must disclose their efforts towards social diversity, including measures for differently-abled employees, gender diversity, occupational health and safety, welfare benefits, median wages, and turnover rates.
5. Social Impact Assessments: Disclosures related to the social impact of the company's activities, including rehabilitation and resettlement efforts, as well as corporate social responsibility (CSR) initiatives.
6. Consumer-related Disclosures: Companies must disclose information related to consumer complaints, such as product recall, product labelling, and complaints related to data privacy and cybersecurity.

Future of ESG in India

Investors are increasingly prioritizing impact investment, where the dual objective is to generate financial returns while also promoting environmental and social well-being. There has been a notable shift in investor mindset, with a greater emphasis on creating sustainable growth for future generations. To attract higher capital in the long run, companies must understand and address ESG risks, develop robust mitigation plans, and incorporate ESG practices into their value chains. The growth of ESG-based funds in India, as measured by assets under management (AUM), has increased 4.7 times in just two years, reaching over INR 12,300 crore. This underscores the importance of ESG compliance for companies aiming to secure capital and thrive in the evolving corporate landscape. It becomes very crucial for the companies to maintain a healthy ESG score which will enable them to operate smoothly and adhere to the social responsibility.