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How evolving ESG disclosure rules are altering investment dynamics

Much progress has been made in this area, but there is still some way to go.

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Last Updated: Dec 11, 2019, 03.23 PM IST|Original: Dec 11, 2019, 03.23 PM IST
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The consideration of material ESG factors is not only logical, but essential for the investment management industry.
By Mary Leung

In recent years, the integration of ESG factors into the investment management process has drawn increasing attention from both regulators and investors. This attention is the result of growing recognition of the impact that material ESG factors have on the long-term prospects and sustainability of a business.

An increasing number of investors accept that an evaluation of an investment opportunity (be it equity or fixed income) is not complete without proper appreciation and analysis of these factors.

In a world where commercial operations are increasingly threatened by extreme weather events, natural disasters, reputation, and stakeholder relationships, the consideration of material ESG factors is not only logical, but essential for the investment management industry.

One obstacle for ESG integration is getting reliable data. Investors need ready access to high quality, comparable and relevant ESG information. Issuers have been under increasing pressure from investors, regulators and stock exchanges to report more ESG information.

Much progress has been made in this area, but there is still some way to go.

And it is true in India
The ESG concept is picking up in India gradually. This year itself we have seen two investment firms – Avendus and Quantum Advisors with three former Tata group employees – launching a $1 billion ESG fund in India.

Last year, Kotak Mutual fund signed the UN-supported Principles for Responsible Investment (PRI) – a global network of investors that attempts to integrate ESG practices into investment practices. Four more investment management firms from India are signatories to PRI. SBI Funds Management renamed its Magnum Equity Fund as Magnum Equity ESG Fund, a thematic fund investing in companies that follow the ESG norms.

What is driving these changes? Fund managers know that integration of ESG factors allows for greater insight into how issuers approach the subject of sustainability. Research shows that a company that pays attention to relevant ESG factors and manages them well delivers better corporate financial performance.

It is not just all about risk management though:
  • investors who can identify those companies that are on the forefront of sustainability — say by delivering solutions to some of the common issues afflicting today’s world — may find additional alpha.

A look at ESG disclosure in India
In the past two decades, all major Asia-Pacific markets have taken steps toward mandating or encouraging disclosures in some or all aspects of ESG.

In India, the initial focus has been on getting larger companies to comply with these rules. This is because they are deemed to have more resources and are expected to provide leadership.

In 2009, India’s Ministry of Corporate Affairs published Corporate Social Responsibility Voluntary Guidelines, recommending that all businesses formulate a corporate social responsibility (CSR) policy. Two years later, the guidelines were superseded by the expanded and more detailed ‘National Voluntary Guidelines on Social, Environmental, and Economic Responsibilities of Business’.

In 2012, the Securities and Exchange Board of India (Sebi) issued a circular that made it mandatory for the largest 100 listed companies to publish an annual business responsibility report. The requirement was expanded to the 500 largest companies in Sebi’s Listing Obligations and Disclosure Requirements Regulations 2015.

The business responsibility report required companies implementing the core nine principles – ethics transparency and accountability, product life-cycle sustainability, employee well-being, stakeholder engagement, human rights, environment, policy advocacy, inclusive growth, customer value – as well as compliance to spend 2% of its average net profit over the past three years on CSR initiatives.

In 2018, the Bombay Stock Exchange published a guidance document on ESG disclosures, a more modern and comprehensive set of voluntary ESG reporting recommendations, informed by global sustainability reporting frameworks. It underscored the importance of ESG disclosures to investors and provided 33 specific issues and metrics on which companies should focus.

Although corporate social responsibility reporting in India is mandatory for the 500 largest companies and voluntary for others, ESG reporting is still only voluntary. This leaves investors and the investment industry at a disadvantage when analysing the full opportunities or risks embedded in a firm’s strategy. But we believe that pressure from investors will prompt companies to improve continuously.

Recommendations for Future Progress
As regulators and stock exchanges are driving changes in reporting and disclosures, there is, nevertheless, room for improvement in terms of quality. More importantly, the value proposition of ESG disclosures needs to be better articulated to motivate companies and boards to make improvements in this area, and not to treat it as a box-ticking exercise.

Here, each stakeholder group has a unique role to play in maintaining momentum and improving the quality of reporting.

It will be critical for corporates to educate the board and senior executives to more fully integrate and report on how ESG fits in with the company’s strategic outlook, risk management framework, and corporate accountability, so that they can steer the company accordingly.

It’s important to encourage listed companies to upgrade the quality and consistency of ESG information, including more detail on what is material ESG information and how it may affect valuation and future corporate performance.

Information is a two-way street: investors should also communicate to issuers what ESG information they would like to see and how that would impact an issuer’s valuation. This will ensure future improvements.

There may not be a one-size-fits-all approach in ESG-related information, but further refinement and understanding of such disclosures will improve their quality, consistency and comparability.

(Mary Leung, CFA, is Head of Advocacy, Asia Pacific for CFA Institute. Views are her own.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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