Why the Securities and Exchange Board of India should be thinking bigger on sustainable issues

What is the cost of ESG inaction in today’s corporate India?

I recently had an engaging meeting with one of the world’s largest general partner investors active in India. We ended up debating whether ESG should be much more than a checkbox exercise and a critical part of companies’ value creation, backed up by corresponding capital expenditure.

As a dedicated ESG adviser, my position will hardly surprise you, but his slightly cynical – albeit refreshingly honest – conclusion was “we need to see more pain and blood in the streets before fund managers and promoters take ESG seriously enough”.

See also: – Partnership to drive India participation in carbon markets

His point stayed with me – because, effectively, it came down to, what is the cost from ESG inaction in today’s corporate India? And when will we see more frequent events in which ESG laggards experience downright negative impacts on bottom-lines? Events such as clients pulling away, factories shut down by authorities, or investors publicly divesting from a company due to an ESG-related scandal – as happened with Page Industries when NBIM divested after child labour practices were found in the production process.

As the country’s financial markets authority, the Securities and Exchange Board of India (SEBI) has the power to introduce a broad suite of sticks and carrots to guide and incentivise desired behaviour in companies. Sure, SEBI has enforced India’s top 1,000 listed companies to report on its self-developed ESG framework – the Business Responsibility and Sustainable Report (BRSR)- but, while SEBI’s approach shines light on the agenda and forces companies to relate (for disclosure purposes), its effect towards pushing real improvements is weaker.

Déjà vu all over again

Many companies’ ESG data are still self-reported and there exist questionable dynamics between certain third-party verification actors as some also perform other advisory services for the very same companies they are assuring. Déjà vu, perhaps?

Additionally, the downside penalty risks associated with wrong information disclosures are simply non-existent and so present a future danger of a growing credibility deficit towards Indian equities. That would be extremely unfortunate for those many Indian businesses that genuinely set improvement targets and work hard to achieve them. Since ‘perception is reality’, however, a broader loss of ESG credibility in India among international investors could become a problem with extra leverage as ESG increasingly becomes a mainstream prerequisite.

This challenge is not confined to India alone, of course, and probably characterises the situation in most markets. Still, as a believer in the value of being a frontrunner on this agenda, I am interested in ideas that can put India on the map as ‘the growth economy that led by example’.

To achieve that, SEBI should among other things, form a unit to scrutinise ESG disclosures of the top 1,000 companies and – by random selection (through a transparent process) – pick out 25 to 50 annually to undergo in-depth due diligence on their claims. This unit should be well-resourced and free from political intervention; its findings must be made public; and any external assurer should face a two-year ban for signing off on false verifications.

Combined, this would be an ‘alpha move’ by SEBI and underscore its dedication to move the needle. With regulations and frameworks being moving targets, the specific framework applied is secondary, whereas driving certified progress is more critical and will build trust in markets.

Are ESG ratings worth their paper?

Beyond market regulator initiatives, the quality of ESG ratings must be scrutinised as the status quo presents a fundamental data challenge for rating agencies. Much like the Sorting Hat in Harry Potter, ESG ratings were initially conceived as an undisputed authority without people questioning their accuracy, mechanism or datasets backing their conclusions. As the ESG agenda has increased in popularity, however, so have expectations and it is becoming quite evident too many ESG rating agencies operating in India have been throwing darts in the dark due to weak and inconsistent data-collection methodologies.

One reflection of the ecosystem’s inability to assess companies’ ESG risk profiles meaningfully came when MSCI’s India ESG Leaders Index ranked Yes Bank at number eight – a year before the latter almost completely collapsed due to manipulated reporting of non-performing assets and a long list of serious corporate governance breaches.

As the Asian Corporate Governance Association stated in December its 2023 yearly report: “Efforts to raise governance standards are greatest in markets that are both large and open to investor engagement, hence Japan scores highest on this question. The next two highest-scoring markets are Hong Kong and Singapore, not so much because companies are more open to engagement, rather because they are international financial centres and home to many regional HQs.

“Investors in these cities use them as a springboard for work around the region as well as locally. Conversely, we find relatively less involvement of foreign investors in the corporate governance debate in mid-sized markets such as Australia, Korea, Taiwan and Thailand. And even less, at this stage, in India. However, we think this may change.”

International alignment

A final consideration is SEBI’s future direction. While SEBI’s temptation to add another string to its own reporting framework bow is understandable, what should this ultimately result in? Indian companies must be aligned and synchronised with international standards and best practice so the upcoming avalanche of ESG requirements from EU-based companies will not overwhelm Indian exporters but, rather, blend in with India’s existing ESG evolution.

We are seeing other foreign exchanges embrace international frameworks, such as the ISSB disclosure standards, and it could be a competitive edge for corporate India to join this movement early. Otherwise, we risk ‘analysis paralysis’ of framework studies, quality differences and misunderstandings at a time where even one framework is vexing enough.

I do feel broadly optimistic about India’s overall ESG trajectory over the long term and see many companies climbing the ESG ladder successfully. That said, I also see a fair number of late-starters that will face valuation ‘haircuts’ or even become stranded assets – businesses investors will want to side-step or divest from today rather than tomorrow.