Rise oF ESG in India
he emphasis on good governance, particularly since it has proven to yield better corporate returns, cannot be dramatized. The importance given to corporate governance by investors to expect that a company exhibiting robust corporate governance practices generate significantly greater returns when compared to companies that exhibit poor corporate governance is established. Rightly so, the fall of some of the biggest corporations in India like Satyam, Kingfisher and most recently, Yes Bank have been credited to governance failures. There is a renewed focus on environmental, social and governance (ESG) focused investments especially across Asia. The data between ESG investments and financial performance added with investors looking at longevity and sustainability, suggests ESG investments to be more than a bull market phenomenon.
With the increasing internet penetration over the recent years and India digitizing faster than the other emerging economies (Mckinsey Report, Digital India, March 2019), people are environmentally and socially more informed and driven to actively pursue environmentally and socially conscious changes. The biggest barrier for conscious consumerism in the Indian market is the availability of alternatives (Survey by Mahindra Group 2019, Conscious Consumerism). This is causing a shift in the investor’s attitude. Investors are now weighing the environmental and social factors in addition to the governance factors. Investors have moved from a purely profit-driven investing to a marriage of socially driven and profit deriving investments thereby making an impact with their investment (Brookings Indian Report 2019). Recently, the CEOs of both Blackrock and State Street, two of the largest asset managers globally, pledged in their annual letters to investors and board of directors of their investee companies to focus on sustainability of their investment strategies. Blackrock, the world’s biggest asset manager, committed in the letter that all its active portfolios will be fully ESG integrated by the end of 2020. (Economic Times, 17 February 2020).
In India, clean energy, financial inclusion, healthcare, and education appear to be the primary focus sectors for investors for their ESG investments. Nearly 67% of all impact investors state that agriculture was their top sector of investment activity and interest. (Brookings India, 2019 and Mckinsey Report, 2017). Further, according to Brookings India Ltd. Report, impact investments in education stands at 67% making it the largest sector alongside agriculture.
The Companies Act, 2013 promotes the social responsibility part of ESG by including provisions for corporate social responsibility activities to be performed by companies. Over time investors have matured to see corporate social responsibility activities undertaken by the company as more than just a mere obligation under law. A company with a strong corporate social responsibility policy indicates to the investor a high-standard risk management team which recognizes non-financial factors such as reputation, environment efficiency and social license to operate that contribute to a company’s valuation.
Another form of ESG based investing in India are impact bonds. These are investments made to translate social milestones into measurable economic returns. Impact investing in India touched USD 1.1 billion in 2016 with an average deal size of USD 17.6 million. (Mckinsey Report 2017). In 2015, UBS Optimus Foundation (UBS) invested in Educate Girls Development Impact Bond, India’s first development impact bond. The milestones stood at 160% of the target at the end of three years and consequentially, the investor received a 15% internal rate of return from the outcome funder. Riding on the high and building off the learnings of the Educate Girls Project, UBS is also involved in Quality Education India Development Impact Bond launched in 2018 (Brookings India Report, 2019).
Even though this space is largely driven by international players, the shift towards ESG based investment can be observed with the establishment of ESG based funds. In 2018, SBI Mutual Fund renamed its SBI Magnum Equity Fund to SBI Magnum Equity ESG Fund. Apart from SBI, Quantum India ESG Equity Fund, Avendus India ESG Fund have also been established to shift focus to and advance sustainable investing. Kotak Mutual Fund and ICICI Prudential Mutual Fund are also looking to launch their ESG products and structuring ESG schemes.
The investor preference towards ESG focused investments can be attributed to the emergence of internet, consumption of information which has led to the taxpayers especially millennials and women make a conscious effort towards bringing this shift. This trend has even led to the emergence of a new result-based instruments which have exceeded expected results.
Even though the social disclosure levels have more than doubled from 2010, India still lags in governance parameters. This is evident from the Satyam fiasco till the most recent fall of Yes Bank. Despite the recommendations on the corporate governance framework for listed entities provided by the Kotak Committee, there remain challenges such as independence and diversity in the board of a company. The proportion of independent directors in India compared to Europe and the US is grim. India has recently tried to implement measures to encourage good governance practices. For instance, individuals who intend to be appointed as independent directors are now required to submit their names to a common data base maintained by the Indian Institute of Corporate Affairs and also pass an online proficiency self-assessment test conducted by the Institute.
Several changes were introduced by the Kotak Committee in order to enhance the corporate governance in listed entities including changes such as holding of annual general meeting for the top 100 listed entities (by market capitalization) within 5 months of closing of the financial year, yearly meeting of the nomination and remuneration committee, stakeholders relationship committee and risk management committee and quarterly filing of corporate governance reports. The intent of the regulator to raise the corporate governance standards by deferring the compliance and disclosure requirements by three weeks to three months instead of a waiver is noticeable. However, the separation of the roles of chairman and managing director remains a contentious issue as majority of the businesses in India are family-run. Although the returns on investments made in family run businesses have been higher compared to other businesses in India, the idea of good governance in most family run business is more of a compliance task than a matter of mitigating the information asymmetry suffered by a minority investor and thereby encouraging meaningful and material transparency in conducting the business of the company. Such business run the risk of poor investment decisions and lower investor confidence. As indicated in the Kotak Committee report, most of the Indian companies’ governance practices will stand the scrutiny of law but will miss the spirit of the legislation.
Defying the tag of being the underdog and criticized for not-likely to stand the test of a bear-market situation, ESG investments have proven to be the trump card for investors, especially during this pandemic, as they have outperformed the companies with lower ESG risk profiles. The ESG stocks in India generated higher returns over other stocks in the first quarter of 2020. Akin to the financial crisis in 2008 which witnessed a rise in membership in the corporate sustainability initiatives, the pandemic has led to a similar trend. Though the idea of ESG investments have not penetrated the Indian market as much, compared to the European and US markets, the investor pressure could lead to improved, not only governance oriented but also environmentally and socially viable, investment practices.
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