ESG (environmental, social, and governance) revolves around a set of criteria aimed at evaluating the sustainability and ethical impact of an investment or business. Now days, ESG considerations are gaining currency among investors and businesses alike, as they recognize the importance of being environmentally responsible, socially just, and governed in an ethical manner.
Globally, it’s not the governments that are concerned about climate change but the private is waking up to the new challenges of being sustainable.
Significance of ESG
There is growing evidence to suggest that companies that prioritize ESG factors outperform their peers in terms of financial returns, risk management, and long-term sustainability. In addition, consumers and employees are increasingly demanding that businesses operate in a responsible and sustainable way, and companies that fail to meet these expectations risk reputational damage and lost business.
Implementation of ESG
There are a number of ways in which ESG considerations can be implemented in practice. For investors, ESG factors can be incorporated into the investment decision-making process, through the use of ESG ratings, screening, and integration. ESG ratings are provided by third-party organizations that assess companies based on their ESG performance, while ESG screening involves excluding companies that fail to meet certain ESG criteria.
Top concerns for ESG investing in 2023 include net-zero emissions targets, employee well-being and data scarcity, according to one annual global outlook.
Recent global developments such as extreme weather events and the outbreak of the Covid-19 pandemic, have brought to the forefront the vulnerability of businesses across the world and have provided an impetus to conversations ESG parameters. Institutional investors, asset managers, financial institutions and even retail investors are increasingly demanding accountability from companies on how their businesses impact various pillars of ESG. ESG reports and disclosures (whether voluntary or regulatory) are increasingly being used to form a basis of decision-making by such stakeholders.
Current challenges with ESG reporting
The development of non-financial reporting relating to ESG across the world has been rather fragmented and inconsistent. While certain countries have developed (or are in the process of developing) their own reporting norms and taxonomies suited to their regional needs, many international bodies have come up with their own disclosure standards to be followed voluntarily. These norms are not always interoperable or comparable. This has resulted in information asymmetry among stakeholders and uncertainty in compliance by companies.
In light of the sharp focus on climate change and commitments under the Paris Agreement, several nations have taken steps to introduce laws to strengthen their ESG reporting framework.
Notably, the European Union (EU) has introduced several amendments to its regulatory framework on ESG reporting parameters over the years. These measures include (i) bringing sustainability reporting at par with financial reporting for businesses, (ii) mandating financial market participants to make the sustainability profile of funds more comparable and better understood by end investors, and (iii) providing taxonomy with appropriate classification for environmentally sustainable economic activities.
Developments in the EU
Non-financial Reporting Directive and Corporate Sustainability Reporting Directive
In 2013, the Non-financial Reporting Directive (NFRD) was adopted by the EU to enable disclosures of non-financial and diversity-related information by certain large companies (covering approximately 11,700 companies and groups across the EU including listed companies, banks and insurance companies). Under this directive, these companies were required to disclose information relating to environmental matters, social matters, respect for human rights, anti-corruption and bribery, and diversity on company boards.
In 2021, a proposal on Corporate Sustainability Reporting Directive (CSRD) was adopted by the EU that amends the existing reporting requirement under NFRD to bring sustainability reporting on par with financial reporting.
Developments in India
In line with global developments, India has recognised the importance of a regulatory framework for sustainability disclosures. This is evident from the various steps that the regulators/ministries have taken in this direction. Some of the key developments that indicate the way forward that each of these regulators/ministries may adopt are discussed below.
Department of Economic Affairs
In January 2021, the Department of Economic Affairs, Ministry of Finance, Government of India, set up a Task Force on Sustainable Finance to put in place a framework for sustainable finance in India. It is also tasked with preparing a draft taxonomy of sustainable activities and a framework for risk assessment by the financial sector.
It is expected that the task force will provide recommendations to strengthen the resilience of India’s financial sector against risks emanating from various ESG issues and set a clear time frame for their implementation.