Environmental, Social and Corporate Governance (ESG) Factors

While examining issues pertaining to corporate governance, a myopic approach is to look at the interest of the shareholders, whose interests are to be protected. On the other hand, there is a school of thought, known as the “stakeholder” approach, which calls for governance of companies with a view to protecting the interest of stakeholders in a company, which include not only shareholders, but also employees, creditors, customers and the community in general (that may be affected by a company’s business and operations). As far as India is concerned, there is something to be said about the fact that company law does cater for the “stakeholder” approach (i.e. that it requires companies to do more than maximize the interests of their shareholders). Without going into any significant detail, that the words “public interest” find mention in several places in the Companies Act is in itself a noteworthy piece of evidence.

This debate becomes far more important in the context of the strengthening cries towards sustainable development, inclusive growth and corporate social responsibility, particularly in developing / emerging economies like India. Apart from businesses themselves, investors (especially institutional investors) are also adopting different approaches towards this issue, with the concept of socially responsible investment (SRI) being one such.

What then is the practice in emerging markets and how successful have the efforts been? This is a question that has been addressed in a survey commissioned by the International Finance Corporation (IFC) and conducted by Mercer Consulting. The Executive Summary in the survey begins as follows:

Over the past five years, phenomenal economic growth in emerging markets has increased the speed of the depletion of natural resources and created tensions with sustainable development. Despite these tensions, sustainable investment (SI), which entails integrating environmental, social and corporate governance (ESG) factors into investment processes, has gradually evolved in emerging markets. IFC, the private arm of the World Bank Group engaged Mercer to conduct this study to identify leading investment managers, pursuing sustainable investment in emerging markets, … and their capacity for integrating ESG into investment processes.

Based on a comparison of various emerging markets, the report does not favourably rank India when it comes to socially responsible investing:

India demonstrated awareness of local social issues but notable absence of active ownership

The Indian EME investment managers scored relatively well in terms of the level of firm-wide commitment to ESG integration, mainly through links with the international parent/holding company where a commitment to ESG had been made at the global organisation level. We also observed a natural tendency for some of the investment managers to consider the implications of local social issues in their appraisal of investment opportunities, particularly on the issues of poverty reduction, access to clean water and sanitation. Where specialist ESG research staff existed at the organisation wide level, they are yet to extend their coverage to Indian companies. Many managers demonstrated a reluctance to utilise voting or engagement as tools for pursuing SI, with most managers opting to sell a stock if they identified a risk, rather than choosing to engage.

Such findings give rise to the questions as to whether a regime ought to be introduced that further enables socially responsible business activities. In that sense, at a legal or regulatory level, the current corporate governance discourse (surrounding the Companies Act and Clause 49 of the listing agreement) is largely limited to shareholder value maximization and the framework does not seem to contain any concrete disposition towards sustainable investment and corporate social responsibility, barring the occasional reference to “public interest”.