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Why an ESG-conscious investing ecosystem is very important for India

India has been a bystander as the ESG (environmental, social and governance) revolution swept through advanced economies and global investment practices. But it’s high time for the world’s fifth-largest and fastest-growing economy, which leads the G20’s ESG agenda, to step up. Fortunately, India is well aware of its responsibilities, and the regulators are forever eager to take on new assignments.

The Securities and Exchange Board of India (Sebi) has been urging businesses to disclose intricate details for transparency and sustainability. The business responsibility and sustainability reporting (BRSR) now mandates such disclosures for top companies. Sebi introduced the BRSR core framework with nine major ESG attributes to guide disclosures. For a conscious ecosystem, transparent and reliable disclosure is just the start; fine-tuning ESG rating practices is vital. Sebi addressed standardization, comparability, and effectiveness of ESG ratings through its recent circular on the subject.

The ESG rating and classification space has been unclear for some time, leaving participants to fend for their own interpretations. Different rating providers, like S&P DJI ESG Scoring, Morningstar’s Sustainalytics, and Crisil’s ESG scoring, have strengths and weaknesses, but the lack of common foundation and overarching principles raises concerns about reliability.

The S&P BSE 100 ESG index stands to be an interesting case in point here. In ESG context, one could consider this an important index. Especially considering that this index draws upon the bellwether S&P BSE 100 index, only includes stocks under coverage by Sustainalytics and relies on the S&P DJI ESG scoring. Interestingly, 17 out of the 53 companies represented on this index, basically one-third, is rated above 30 by Sustainalytics. Five are rated above 40. Sustainalytics recommends ESG Risk ratings from 30-40 be interpreted as ‘high risk’ and 40+ as ‘severe risk’.

As a corollary, consider ESG-focused mutual funds that demonstrate varying interpretations of ESG standards, resulting in minimal overlap and subjective approaches. With 160 domestically listed and 40 overseas entities invested in collectively, the segment’s diverse universe reflects each fund’s distinct portfolio. Clearly, the interpretation of ESG parameters is a matter of perception.

Of the 161-constituent universe that ESG-focused mutual funds invest in 78 or almost 50% of the constituents have been scored 60 or below on a 100-pointer ESG rating scale by CRISIL. 100 being the highest here.

To establish a common foundation and contextual evaluation parameters, Sebi introduced guidelines in its recent Master Circular for ESG rating providers. This move is expected to foster progress in the second hemisphere of an ESG-conscious ecosystem.

The circular’s most notable proposition is the inclusion of a Parivartan score, rewarding progress alongside absolute status in ESG ratings. This move incentivizes transition finance, encouraging companies to raise funds for ESG goals. The progress-based reward system also fosters commitment to achieving net-zero in the future. Another significant step is providing clear guidance on business model choices, ensuring ESG ratings providers adopt a distinct payment model to avoid conflicts of interest. The circular’s annexures offer a common foundation by laying out contextualized ESG parameters for Indian dynamics, enabling ESG rating providers to develop robust models with minimum coverage standards.

Packing some more action into the agenda, Sebi’s recent guidelines permit mutual funds to launch multiple ESG-oriented funds, each focusing on specific strategies such as exclusion, integration, best-in-class, positive screening, impact investing, sustainable objectives, or transition investments. These funds must allocate at least 80% of their corpus to the chosen strategy, paving the way for a more nuanced ESG-conscious investing ecosystem.

With improved ESG-focused disclosures and a well-established ESG ratings framework, the next step involves raising awareness in the investing ecosystem. If the mutual fund industry’s efforts are any indication, we are on the right path.

Conversations around ESG are migrating from academia and industry conventions to boardrooms and investment models real fast. The efficacy of regulations and pace of implementation promises India an important seat at the ESG-conscious global table.

Nirav Karkera is head of research at Fisdom.

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Updated: 02 Aug 2023, 10:14 PM IST

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