ESG — a value ecosystem for corporates

M Srikanth/KG Suresh | Updated on July 27, 2021

Sustainable practices will pay off   -  istock

Fulfilling ‘Environmental, Social and Governance’ norms will improve business performance, credit ratings and financial returns

In June, Crisil released the ESG (Environmental, Social and Governance) scorecard for 225 listed companies across 18 sectors, redefining corporate India’s approach to risk management for sustainable value creation. Ever since the introduction of the United Nations Principles for Responsible Investing (UNPRI) in 2006, the ESG framework has been recognised as an inextricable link of modern day businesses.

The surge in global sustainable investment flows (assets under management rose from $6 trillion in 2006 to $110 trillion in May 2021) suggests that ESG is here to stay and will act as a safeguard for a company’s long-term success. According to a McKinsey report (2019), a strong ESG proposition translates into superior business performance, better credit ratings, and higher financial returns.

A look at how ESG creates value for corporates and their stakeholders: communities, customers, employees, governments, investors, regulators, and suppliers.

Growth in revenue: Aligning with the ESG principles helps companies to expand existing markets and provide new avenues for growth as part of their blue ocean strategy. Top-line growth of a company is ensured if it addresses emerging environment and social needs or enters into un-served/underserved customer segments by offering green products and services, even at a premium.

Enhanced public image: As it is perceived that ESG-compliant companies are value creators, they have ease of access to resources — natural, financial, human talent, etc — at a lower cost. While nine Indian companies collectively mobilised $2.33 billion by issuing green bonds, global demand for these bonds crossed $1 trillion during FY21. Thus, ESG is critical to fund raising and free access to other resources is equally important in countries like India wherein companies face stiff resistance from local communities while taking up new projects in their reserved areas. Posco steel plant in Odisha is a classic example in this context.

Long-term sustainability: Adherence to ESG framework encourages companies to search for more sustainable investment opportunities that will create competitive advantage in the long run. The companies with lower carbon emissions, waste reduction, optimum water-usage, higher employment generation and relatively better disclosures will score high on ESG index. For instance, a company’s contribution to climate change through use of renewable energy, e-office and biodiversity can reduce operating costs, and enhance its long-term sustainability.

Optimising capital expenditure: According to the Crisil report, about 80 per cent of the institutional investors intend to integrate ESG with their decision-making process. Conformity to ESG guidelines will optimise capital expenditure of the companies by enhancing return on investment and minimising their stranded investments in the projects with environmental concerns/governance issues.

Increasing employee productivity: Integration of ESG with the company’s ecosystem instils a ‘purpose-driven-life’ among the employees so as to excel in their jobs. Better labour relations, and employee satisfaction enhance the overall returns to the stakeholders by preventing strikes, lockouts, etc.

Reducing costs/risks: As per the UNPRI’s data, investment in non-ESG companies could bear up to 28 per cent more risk annually than that of investment in ESG-integrated companies in the same industries. Fulfilment of ESG norms such as redress of shareholder grievance, human rights and gender diversity of the companies will result in fewer penalties and enforcement actions. Besides, non-observance of ESG may negatively impact the market price of the company shares.

Better compliance with regulatory guidelines: Companies following the ESG framework may have greater strategic freedom and are free from regulatory pressures which may earn support/subsidies from the government.

The way forward

As on date, UNPRI regulations are in vogue across 50 countries. The Kotak Committee on corporate governance (2017), introduction of Nifty 100 ESG Index (2018), and launch of Business Responsibility and Sustainability Reporting (BRSR; 2021) by SEBI augur well for the investing community in India in general, and ESG-oriented market in particular.

Given the higher returns and lower volatility in ESG-company stocks, retail investors may also find it an attractive proposition. India can reach its avowed goal of $5 trillion economy by 2025 if the corporate world embraces ESG with an open mind.

Going forward, ESG-compliant MSMEs may be patronised by the investors thereby making a power shift from ‘bank-led economy’ to ‘capital market-led economy’. Energy efficiency among MSMEs and financial inclusion in accordance with the SDGs by 2030 will be realised if the ESG is followed in letter and spirit.

In sum, companies have reached a tipping point wherein the Covid-19 is a wake-up call for building risk-resilient businesses. As the corporates don’t just function in a vacuum, there is a compelling need to evaluate their sustainable, responsible, and ethical practices along with their financial metrics.

Srikanth is Associate Professor and Director (Finance), DDU-GKY, National Institute of Rural Development and Panchayati Raj, Hyderabad, and Suresh is Associate Professor, ICFAI Business School, Hyderabad. Views are personal.

Published on July 27, 2021

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