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Economic, Social & Governance Principles – An Analysis

February 16, 2017[2017] 78 183 (Article)


Partner at Cyril Amarchand Mangaldas

The debate on Environmental, Social & Governance (ESG) principles in relation to responsible investing started globally more than a decade back with thoughts of such principles operating as voluntary guidelines. With the economic melt down of 2007-2008, rising concern for governance issues, human rights, environment protection and specifically, climate change issues, the level of importance given to the implementation of these principles became need of the hour to create a long term positive impact from both financial as well as social responsibility perspective. The recent Volkswagen (VW) diesel emission scandal increased the need for better ESG related risk assessment; the stakeholders of VW had sued VW for billions of dollars of loss in value of their stake resulting due to violation of environmental laws by VW. The interdependence of financial and social factors isn't a new thing but the need for creation of effective and mandatory compliance and disclosure regime in respect of the same is. ESG and Corporate Social Responsibility (CSR) principles should be based on a 'must have' rather than a 'nice to have' regime.

In this article I have first dealt with the Principles of Responsible Investment (PRI) Initiative supported by the United Nations and then with the voluntary as well as mandatory legal and regulatory regime in India in relation to ESG and how one may be able to improve the same. Later on in this article I have dealt with the way global financial investors have tried to integrate the ESG principles into their investment decision making process and risk assessment, making it financially material for their portfolio companies and potential target companies to be ESG complaint.

Principles of Responsible Investing

The United Nations-supported PRI Initiative is an international network of investors working together to put the six principles for responsible investment into practice1. Its goal is to understand the implications of sustainability for investors and support signatories to incorporate these issues into their investment decision making. The six principles, that are more in the nature of an oath statement are, (i) We will incorporate ESG issues into investment analysis and decision-making processes, (ii) We will be active owners and incorporate ESG issues into our ownership policies and practices, (iii) We will seek appropriate disclosure on ESG issues by the entities in which we invest, (iv) We will promote acceptance and implementation of the Principles within the investment industry, (v) We will work together to enhance our effectiveness in implementing the Principles, and (vi) We will each report on our activities and progress towards implementing the Principles.

In implementing these principles, signatories contribute to the development of a more sustainable global financial system2. Many investors and signatories to UN PRI have incorporated these principles into their policies with the changes they wanted to make to it as per their choice to ensure better risk assessment of the investment decisions. As of November 15, 2016 there are 1596 signatories to PRI3 out of which 1060 are investment managers. IDFC became a signatory on August 18, 20094. The attempt to create more responsible system is therefore, finding appreciation as a practical matter and effective implementation will improve with time with change in laws & regulations, self realization of better governance and more shareholder activism.

ESG for India Inc - Mandatory or voluntary?

As of now there are only two signatories from India to the PRI which necessarily does not help us in terms of global perception of India's ESG commitment. But with steps taken by MCA and SEBI and also by many investors and companies in India, the India Inc. score card may see an upswing. Needless to say that being a signatory something like a PRI creates a better market perception globally especially, when the country is already taking positive steps towards addressing the ESG issues.

Steps taken by Ministry of Corporate Affairs

Ministry of Corporate Affairs (MCA) in India came up with the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business (NVGs) in July 2011. The NVGs adopted the global general principles of responsible investing but kept the implementation of the same rather optional by not making the guidelines mandatory. NVGs simply urged the businesses in India to follow the 'triple bottom line' approach and designed an optional framework on 'apply or explain' principle.

The need for making ESG principles mandatory at least for large businesses was considered necessary since optionality in following the same made it an empty formality. The flaw in the voluntary compliance regime was the thought that reputational concerns of the big brand names alone will make the businesses follow these standards anyway. The (Indian) Companies Act, 2013 (Companies Act) introduced the concept of Corporate Social Responsibility (CSR) for Indian companies that are well placed financially. CSR is mandatory for companies having a net worth of at least Indian Rupees 500 crore or a turn over of at least Indian Rupees 1000 crore or a net profit of at least Indian Rupees 5 crore during any year. Such companies have to constitute CSR committee of the Board of Directors and have a CSR Policy. Such companies have to spend at least 2% of the average net profits of the company made during the 3 immediately preceding financial years. CSR activities are illustratively listed in Schedule VII of the Companies Act which include environment sustainability, promoting education, gender equality, eradicating poverty, rural development project, etc. Clarification issued by the MCA on June 18, 2014 inter alia states that CSR activities should be undertaken by the companies in project/programme mode and one-off events such as awards, marathons, charitable contributions, etc. do not qualify as CSR expenditure. These rules certainly make the relevant companies take the CSR initiate seriously with a well chalked out plan. However, one should bear in mind that CSR is only a subset of the broader ESG principles and will remain an ever evolving initiative just like the ESG initiative.

Steps taken by SEBI

The Securities & Exchange Board of India (SEBI) took an interesting step by coming up with an amendment to the listing agreement on August 13, 2012 (effective from December 31, 2012) and introduced Clause 55 in the listing agreement making it mandatory for the top 100 listed companies based on market capitalization as on March 31, 2012 at BSE Limited (BSE) and the National Stock Exchange of India Limited (NSE) to include a Business Responsibility Report (BRR) as a part of the annual report of such listed entities. For the companies outside of such top 100 companies the disclosure was voluntary. Thereafter, on November 4, 2015, SEBI issued another circular on format for BRRs covering ESG issues as the listing agreement had been done away with by the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) which came into effect on September 2, 2015. As per the current applicable Listing Regulations, Clause 34(2)(f) of the Listing Regulations makes it mandatory for top 500 companies (instead of 100 w.e.f. April 1, 2016) based on market capitalization calculated as on March 31 of every year requiring such companies to issue a BRR as a part of their annual report describing the initiatives taken by them from ESG perspective.

The BRR contains disclosure of the relevant listed company from ESG stand point and covers inter alia the following, (i) List of 3 products/services whose design has incorporated social or environmental concerns, risks/opportunities, (ii) Strategies/initiatives adopted by the company to address global environmental issues such as climate change, global warming. etc., (iii) Does the company identify and assess potential environmental risks? (iv) Are the emissions/waste generated by the company within the permissible limits given by the pollution control boards? (v) Number of show cause notices received from the pollution control boards which are pending as on the end of the relevant financial year, (vi) Company's contribution to community development projects, (vii) Consumer satisfaction surveys, (viii) Cases filed by stakeholders regarding unfair trade practices, anti-competitive behavior, etc.?, (ix) Complaints relating to child labour, (x) Company's policy on human rights -whether it cover its group entities.

The BRR has to state the names and details (e.g. DIN, email id, etc) of directors responsible for the same. Listed companies are in fact clubbing the CSR, ESG reporting and NVGs in the BRRR and publishing the same in their Annual Reports (e.g. TCS, HUL, ITC). Since the introduction of this requirement in 2012 by SEBI, followed by a five-fold expansion by SEBI in 2016, the number of companies that will publish the BRR will go up and it would be interesting to see the level of details these 500 companies will provide.

Why do we need SEBI for ESG?

One might ask that laws relating to environmental protection, human rights, corporate governance already exist in India, then why was there a need to build something additional of this sort in SEBI's mandatory regulatory framework? The rationale behind such inclusion is the fact the general public would be ignorant about the status of compliance of material laws on these aspects by the listed companies and also, the general public may not know about the initiatives taken by the listed company towards these compliances. In my view, the BRR does not necessarily cast additional substantive legal obligations above the existing laws but requires disclosures to be made for the market to know the status of certain compliance and steps taken by the listed company towards all these relevant requirements. Since a significant disclosure may get priced5, such disclosures will be used by the investors to take a decision on their investment in the company and for the already existing sophisticated investors to know whether there is a scope of improvement and how to help the company in improving the ESG compliance. This indeed depends upon the percentage of stake held by the investor in the Company and the investor's long term investment strategy.

Is SEBI's market cap categorization approach enough?

In my view the approach of making the disclosures mandatory from a pure market capitalization perspective is not necessarily helpful. Trying to achieve better governance framework with a numbers only approach may not work. SEBI will need a more nuanced approach towards categorizing companies which need to mandatorily comply with these requirements. If the approach continues to be the one taken as of date today, it would mean that only the market cap is the key driving factor for mandating disclosures and compliances. SEBI should consider making it a combination of market cap and industry in which the company operates; with this approach, for example, companies with lesser market cap but significant impact on the environment (like a company but multiple manufacturing plants) will also be mandated to disclose their ESG initiatives. SEBI could take - say - top 506 companies by market cap in each industry segment and make the BRR and ESG disclosure compulsory for them. In achieving this SEBI could take help from industry experts in identifying better ways to achieve a more meaningful categorization to make the ESG initiative punchier.

Needless to say that change in approach, fine tweaking the existing set of regulations and disclosure requirements will remain a work in progress as ESG is a complex issue to deal with from a more holistic stand point.

Integration of ESG into investment decisions

ESG principles are not merely a theory anymore but are becoming a part of the principles of investment followed by sophisticated investors globally, irrespective of whether they are pension funds, sovereign wealth funds, private equity investors, etc. International Finance Corporation (IFC) came up with Performance Standards on Environmental and Social Sustainability (IFC Standards) in the year 20127 making the IFC Standards an integral part of IFC's risk management strategy. IFC Standards are 8 requirements that a target entity has to meet throughout the life of investment by IFC. These requirements cover working conditions, child labour, community health and safety, pollution, land acquisition, bio diversity, cultural heritage, etc. IFC Standards state clearly that the target entities have to meet the national law requirements of the host country and if the standards in host country are different from the IFC Standards then the target entities have to meet the requirements that are more stringent of the two.

In 2009, Kohlberg Kravis Roberts (KKR) became a signatory to the United Nations-backed PRI and helped to develop the guidelines for responsible investing as a member of the American Investment Council (formerly the Private Equity Growth Capital Council)8. In 2013, KKR formalized its own Private Equity ESG Policy and began communicating it to its employees9. KKR's website states that KKR believes that the thoughtful management of ESG issues is 'smart business' and sees it as an essential part of long-term success in a rapidly changing world10.

Some investors are attempting to integrate the ESG principles with their responsibilities by stating that the ESG principles are consistent with their Board's fiduciary duties to ensure that the investment process is more responsibility driven, e.g. California State Teachers' Retirement System (CalSTRS)11 stated in its Investment Policy for Mitigating Environmental, Social and Governance Risks that the ESG issues outlined by the CalSTRS 21 Risk Factors are consistent with their Board's fiduciary duties. Also, recognizing the importance of investing for a sustainable future, OPSEU Pension Trust, Canada (OPTrust)12 issued a Statement of Investment Policies and Procedures13 stating that it has established a responsible investing program and implemented a range of measures to identify, monitor and assess ESG-related risk as part of its investment activities; the statement goes on to say that this approach reflects OPTrust's fiduciary responsibility to the Plan's members and sponsors, which includes identifying and addressing all factors that could affect the Fund's investment returns. The 2015 Responsible Investing Report14 issued by OPTrust states that as part of OPTrust's Responsible Investing program, OPTrust commits to the integration of material ESG factors into its investment decision-making processes and ownership practices.

This shows that these investors are not passive financial powerhouses and if any company is ignoring ESG issues, the fact that investors are integrating the ESG factors into their investment decisions and risk analysis and some of them are even taking a step further by tying up the ESG risk issues to their fiduciary duties, non-compliant companies will become or rather, already are - less desirable targets. This makes ESG factors financially material for both the investors and the target companies even if each of parameters of ESG factors cannot really be priced. The overall positive impact of all this is that whether the investors are tying up these ESG factors to fiduciary duties or mandatory compliances or not, there steps are being taken to create a more responsible system of investment and disclosures.

Ckinetics Report - Emphasizing the practical relevance of ESG factors

Cracking the Conundrum - a report published by Ckinetics has also indicated that as more businesses begin to measure and disclose on their ESG practices, more capital will begin to come into India15. As per this report, (i) the AUM of Indian Rupees 3 trillion is largely held with social investors, E&S funds, Socially Responsible Investing (SRI) funds and Developmental Financial Institutions (DFIs); (ii) in addition, another Indian Rupees trillion of capital is being managed by Indian and global banks, using the E&S (Environment and Social) criteria. The table below as given in the report depicts the capital management of these investors as in the year 2012:

Investors already using E&S measures as per this report:


Cracking the Conundrum report contains an estimation16 that, should adoption of standardized E&S disclosure and reporting take place, the amount of capital being deployed by finance + investors would be at Indian Rupees 17.3 trillion instead of at Indian Rupees 7.5 trillion by [the year] 2022, due to:

(1)   Increased coordination between finance + investors
(2)   Increased use of E&S information by mainstream investors.

Should non-compliance trigger an exit?

Apart from the non-complaint companies being less desirable targets, another tricky set of questions that arise in case of non-compliance by existing portfolio companies are, whether an investor should exit or stay or stay and help the portfolio company improve its ESG compliance in any manner the investor can. The answer to all these questions is not an easy one, it will depend upon investor's own ESG policies, jurisdiction of investment, ethics, financial impact (e.g. in a case similar to VW diesel scandal case, the impact could be very high), duration of investment, return to the investors in the fund (e.g. in the investor is a private equity fund), etc. Some news reports suggest that some global investors have exited Indian listed companies as they see a significantly higher degree of risk associated with ESG factors e.g. The Economic Times carried a story on October 27, 2016 titled "Indian Companies not Adhering to Environment Guidelines Could be Snubbed by Global Investors"17 (ET Article). The ET Article stated that pension funds managed by Norges Bank sold off equity investments in seven Indian companies - Coal India, CESC, Reliance Power, Gujarat Mineral Development Corporation, NTPC, Tata Power and reliance Infrastructure - as a part of the global strategy of Norges to get rid of portfolio constituents that dealt with thermal coal. The document titled 'Grounds for Decision - Product based coal exclusions' dated April 14, 201618 published by Norges states that where thermal coal is a significant part of a company's business activities, the company may be excluded from the fund's investment portfolio and hence, it divested its stake in the above listed companies19. This empirical evidence shows increased focus of major financial investors with long term strategy to 'invest and remain invested' in companies with a high ESG compliance and shun the rest in their sole discretion. Whether an investor should exit the portfolio company or express its concerns to the company on its ESG compliance requesting the company to comply with the material ESG factors or the investor may itself assist the company in becoming ESG compliant if the investor has the wherewithal to help the company achieve the same can be decided on a case to case basis.

Also, the risk assessment based on ESG compliance of the company would have to be based on 'materiality' of the factors that have not been complied with by the relevant portfolio company. How will one define materiality would also be dependent of various factors and one single definition may not addresses everyone's thought process. In this regard its worth mentioning KKR's Private Equity ESG Policy (KKR's ESG Policy)20 which inter alia states that KKR commits to consider 'material' ESG issues in the course of its due diligence and in the monitoring of portfolio investments to the extent reasonably practical under the circumstances subject to the provisions of the Partnership Agreement and Private Placement Memorandums of the fund. KKR's ESG Policy defines "material'" ESG issues as those issues that KKR in its sole discretion determines have or have the potential to have a direct substantial impact on an organization's ability to create, preserve or erode economic value, as well as environmental and social value for itself and its stakeholders.

Therefore, materiality associated with ESG factors would vary on a case to case basis and from one kind of business to another irrespective of whether all the ESG risks can be priced / valued monetarily or not.


Creation of a more robust and nuanced system of disclosures and compliance with ESG factors drives the company's management for a better focus on creation of sustainable business models with adequate inter play between pure financial goals and social & environmental impact. ESG factors become legally and financially material not just for the potential target companies but also for the existing portfolio companies given that the investors' risk assessment would be based on status of ESG compliance at the time of investing and also during the life of investment.


1. C.f. /press-releases/ pri-publishes- new-guide- for-asset- owners-on -esg-integration (November 15, 2016). PRI is supported by, but not part of, the United Nations, c.f.

2. Id.

3. C.f. (November 15, 2016).

4. C.f. signatory-directory/ ?co=105&sta= &sti=&sts= &sa=join&si =join&ss=join&q= (November 15, 2016).

5. The focus of this article is not to debate on whether the markets are 100% efficient in terms of reflecting all publicly made disclosures in the price of the listed stock.

6. The number 50 here is only an example and should not be looked at from a pure mathematical stand point. My proposal is not that SEBI should take 10 industry segments and multiply it by 50 and get to 500 companies. The proposal is more pragmatic to ensure lesser excuses by non-complaint businesses based only on lesser than the prescribed market capitalisation.

7. Available at wps/wcm/ connect/c8f524004a73daeca09afdf998895a12/ IFC_Performance _Standards.pdf? MOD =AJPERES

8. C.f. responsibility/ esg-management/our-commitment (November 14, 2016).

9. Id.

10. C.f. (November 14, 2016).

11. CalSTRS was established by law in 1913 to provide retirement benefits to California's public school educators from prekindergarten through community college. Today, CalSTRS is the largest educator-only pension fund in the world, and the second largest pension fund in the U.S. The market value of the CalSTRS Investment Portfolio was approximately $193.2 billion as of September 30, 2016. C.f. (November 12, 2016).

12. With net assets of $18.4 billion, OPTrust invests and manages one of Canada's largest pension funds and administers the OPSEU Pension Plan, a defined benefit plan with almost 87,000 members and retirees; C.f. aboutoptrust/ default.asp (November 16. 2016).

13. Available at, documents/ Investments/ Statement -of-Investment -Policies- and-Procedures.pdf (November 16. 2016).

14. Available at, documents/ Investments/ 2015- Responsible- Investing- Report.pdf (November 16. 2016).

15. crackingtheconundrum / (November 16, 2016). Also, See ESG Score of India Inc: 2014, published by Sustainable Businesses Leadership Forum.

16. See page 49 of this report that can be downloaded from crackingtheconundrum / (November 16, 2016).

17. Available at /news/ economy/ finance/indian-companies-not-adhering-to-environment- guidelines- could-be- snubbed-by-global-investors/articleshow/55080383.cms

18. Available at contentassets/ 08b0787eae8a4016bd06bfeba0067e32/20160414 – grounds – for - decision--- product-based-coal-exclusions.pdf (November 14, 2016).

19. Details of the decision taken by Norges are mentioned in this published statement.

20. Available at (November 16, 2016).

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