ESG: New Governance Standards or Financial Burden on Public Shareholders

An overview: ESG and its implementation

Whether it is Dr Mohieldin’s “WTF” lapel or Greta Thunberg’s protest memes, the ever-expanding nature of climate awareness and the lack of implementation despite several policy measures being resorted to, shifts the onus to human agency and subsequent inadequate execution of policies. ESG (Environment, Social, and Governance) reflects the values and ethics aimed at sustainable outcomes for the betterment of the society at large, which is then translated into policies and regulations.¹ The author believes that although necessary in the present times, coupled with fallacious enactment ESG Regulations unload financial baggage on stakeholders, especially public shareholders as the company directs its resources or furnishes additional resources in furtherance of their compliance or to meet the standards of the established ESG norm, which will be further elaborated upon.

Issues around ESG considerations

ESG initiatives which encompass wide spectra of issues ranging from climate change issues to human rights to internal systems and legal compliances, however there are certain issues around its implementation worldwide such as the absence of a standardised mechanism or inconsistencies in its measurement and definitional clauses. It is challenging for businesses and investors to analyse and benchmark their performance because different organisations and stakeholders use various metrics and criteria to assess ESG performance. Being unsure of what a company is doing to enhance its ESG performance can also cause uncertainty and mistrust among stakeholders.

ESG activities may also lead to inconsistencies between the interests of various parties, including shareholders and employees, or between short-term financial performance and long-term sustainability. Companies may be hesitant to take changes that could have a detrimental effect on their short-term financial performance and may be prone to put the interests of shareholders before those of employees or the environment.

An additional issue with ESG is the prospect of “greenwashing”, which happens when businesses exaggerate or misrepresent their environmental or social effect in an effort to win over investors or consumers who value social responsibility. It may be challenging for the stakeholders to distinguish between businesses furthering ESG as a practice they believe in and those which are merely doing it under obligation.

Further, inconsistent reporting of corporations’ ESG performance is another issue. Investors and other stakeholders find it challenging to assess and benchmark the performance of various companies due to the lack of consistency in how organisations report their ESG performance. Thereby, in this case, the businesses could feel compelled to highlight their achievements or exclude data that might be viewed unfavourably.

Moreover, investors and businesses do not fully comprehend or are aware of the advantages and difficulties of ESG projects. ESG projects may not receive the backing they need since many investors and businesses may be unaware of the possible advantages or difficulties they may present. Thereby, it can be undoubtedly noted through the reasons that although ESG initiatives have the potential to have a big impact, there are also a lot of difficulties and issues that need to be addressed for which companies, investors and stakeholders of the company but align their interests and formulate uniform standards.

Reverberations of ESG on public shareholders

As we proceed to the intricacies of the impact of ESG, we can note that the public shareholders, firstly, through increased costs for companies, are being heavily impacted. The increased expenses can be seen through a practical example, for instance, a business might need to spend money on new technology or equipment to lessen its carbon footprint, or it might need to recruit more people to guarantee that labour rules are followed. These expenses may ultimately have a detrimental influence on the company’s bottom line and shareholder returns.

Secondly, ESG activities can also have an influence on public shareholders by changing how much a company is worth i.e. its valuation. Stock prices for companies that are seen as leaders in ESG performance may rise, while stock prices for companies with slow progress may fall. This may enhance stock market volatility and make it more challenging for investors to forecast the future success of their assets.

Thirdly, some shareholders may object to certain ESG activities, including making investments in renewable energy, in addition to higher prices since they might not be in line with their own financial or personal principles. To understand this, we take an example; for instance, some investors can see these investments as a diversion from the main objective of maximising financial profits or their expansive policies, or they might have ideological issues with a particular technology or government policies.

While these are some pertinent disadvantageous factors, the author acknowledges the statistical evidence favouring the implementation of ESG, with better long-term outcomes and reduced financial tribulations along with the furtherance of SDGs (Sustainable Development Goals) by the UN General Assembly (UNGA).²

Administration of the ESG framework in India

The fulfilment of the ESG compliances suffer from several hindrances because of the framework devised in India, which is, firstly, brought to the fore by the deficiencies in clarity in terms of the norms or extensive guidelines. The fact that firms and investors are largely unaware of the benefits and challenges of ESG operations raises serious concerns. ESG projects might not get the support they require because so many investors and companies might not be aware of the potential benefits or challenges, they could provide.

Secondarily, in India, the concerns for long-term sustainability frequently get lost in the concentration on short-term financial achievement. Companies may be hesitant to take changes that could have a detrimental effect on their short-term financial performance and may be prone to put the interests of shareholders before those of employees or the environment. This may result in a lack of commitment by businesses to adopt ESG initiatives and a lack of investor support for businesses that place a high priority on ESG performance. The shortage of resources and capability among businesses is another significant obstacle to ESG implementation in India.

Further, most micro, small, and medium-sized enterprises (MSMEs) in India, with around 1.2 crore MSMEs registered,³ lack the adequate resources and knowledge necessary to implement ESG initiatives, measure, and report the progress. This can result in a lack of confidence with stakeholders like investors, which makes it challenging for businesses to raise money and enhance their ESG performance.

Moreover, the author is of the view that the lack of precise and trustworthy data on ESG performance is another major issue which clouds the judgment of the investors and other stakeholders, as they find it challenging to assess and benchmark the performance of various companies due to the lack of consistency in how organisations report their ESG performance. This could, in turn, result in businesses feeling obligated to downplay facts that might be seen adversely or to favourably portray their performance. Consequently, there may be a lack of trust among stakeholders. It may also be challenging for businesses to recognise and solve performance improvement areas.

Due to the expenses involved in gathering and reporting on environmental, social, and governance (ESG) data, Business Responsibility and Sustainability Reports (BRSR) can be a financial burden for public stakeholders, such as small and medium-sized businesses (SMEs). These expenses could include the cost of data collection i.e. it can be expensive and time-consuming to gather and analyse ESG performance data, especially for businesses with limited resources like MSMEs, reporting i.e. the time and financial inputs needed to verify that a BRSR is correct and in compliance with applicable standards makes it expensive to prepare and publish, auditing i.e. it may be more expensive to review the BRSR with an impartial third-party auditor and lastly, communication and engagement, it can be expensive as well because it may call for supplementary financial inputs to make sure that the business is successfully informing stakeholders about its ESG performance.

It is suggested that the aforementioned solutions could be dealt by leveraging existing data for a reduction in data collection costs, by disentangling the process i.e. by simplification and streamlining by resorting to uniform reporting guidelines, by involving the usage of technology to computerise certain data analytics and statistics or further, by engaging in third-party collaborations i.e. other stakeholders such as NGOs or associations or unions could share data and reduce the cost of the process.

Thereby, it can be assessed that there are significant issues with the implementation and application of ESG framework in the Indian context, which can be resolved through streamlined problem solving.

Conclusion and way forward

While the framework of ESG is highly pertinent and in line with the sustainable goals, the practical employment of the same needs to be assessed with the market and the economic conditions of the nation. Thereby, the liability lies not in the framework but its operational aspects.

To assess the way forward for the enforcement of ESG constructively, measures such as:

(i) Strengthening regulations or guidelines. — Improved rules and recommendations for corporations to report their ESG performance and risks have recently been implemented by India’s regulatory organisations, including the Securities and Exchange Board of India (SEBI) and the Ministry of Corporate Affairs (MCA). However, there is still room to make these rules and recommendations holistic and more enforced.

(ii) Increasing awareness and education. — Driving change in India requires increasing understanding of the value of ESG norms among businesses, investors, and stakeholders. Initiatives like workshops, seminars, and other training methods can help with this.

(iii) Building capacity. — Companies in India must be able to adopt ESG standards, which includes having the data collection and analysis tools. By giving businesses the appropriate tools and help, such as technical support and training, this can be accomplished.

(iv) Encouraging long-term thinking. — Instead of being viewed as a distinct and short-term priority, ESG factors should be included into long-term business strategy and decision-making processes.

(v) Encouraging stakeholder engagement. — To understand and manage their ESG concerns, as well as to develop trust and a positive reputation, businesses should interact with their stakeholders, including employees, clients, suppliers, and local communities.

(vi) Encouraging investors to integrate ESG considerations. — ESG factors should be considered by investors when making investment decisions and strategies because doing so is not only ethical but also profitable.

(vii) Encouraging government and private institutions to collaborate. — To create a favourable climate for businesses to implement ESG standards and for investors to invest in ESG compliant enterprises, the Government, commercial institutions, and civil society should work collaboratively.

Alternatively, in arguendo, against the stringent application of ESG norms in India, a developing country, the author wants to address the principle of “common but differentiated responsibilities” which gives the expansive scope to least developed or developing countries to adapt to climate change or other norms with a relaxed threshold of compliance. By engaging with either an eased threshold or with the aforementioned suggestions, companies, investors and even the Government can adequately promote sustainable and healthy industry practices which is in line with the global objective.