[Avani Hegde and Praneel Panchagavi are 3rd year B.A., LL.B. (Hons.) students at Symbiosis Law School, Pune]
The Securities and Exchange Board of India (SEBI) issued a circular on July 12, 2023 notifying the mandate for environmental, social, and governance (ESG) disclosures and assurance requirements for value chains of the top 250 listed entities by market capitalization from the financial year 2024-2025. The introduction of ESG disclosure for value chains by SEBI is pertinent in the current context as the mandate ensures inclusion of smaller entities and intermediaries including the micro, small and medium enterprise (MSME) sector in compliance with the disclosure norms. A value chain encompasses upstream and downstream activities involved in the operations of an entity and its inclusion in the ESG disclosure framework provides a holistic view of an entity’s ESG impact. While the mandate has galvanised the market into improving the transparency of ESG disclosures, thereby augmenting their investments in ESG, listed entities are likely to face challenges in effective implementation of the framework and compliance with the same.
This post assesses the positive aspects of the regulatory framework on ESG disclosures and examines potential challenges it may present. It concludes that the framework, while ambitious in its scope and capable of fostering a responsive corporate ecosystem, is faced with issues that may hinder its implementation. The post subsequently delves into suggestions intended to deftly redress some of such pressing issues and pave the way for a more robust and responsible corporate landscape.
The introduction of value chain disclosures offers a holistic regulatory framework for corporate governance, ensuring greater transparency and accountability of entities’ financial as well as socio-environmental impact. The incorporation of key performance indicators (KPIs) focused on the Indian markets (both present and emergent) will aid the process of meeting the global ESG reporting standards.
The inclusion of non-financial parameters in disclosures pertaining to value chains embodies the principle of “double materiality”, which refers to the amalgamation of impact materiality and financial materiality of an entity. It is centred on the notion that an entity’s operational information should not only elucidate the financial impact of its operation on the entity’s value but should span its impact on society and the environment.
Moreover, SEBI’s inclusion of preliminary parameters under “BRSR Core”, a subset of the business responsibility and sustainability report (BRSR), is a valued addition as it eases the burden on small listed entities in respect of reporting on complex parameters laid down in the BRSR. The incorporation of BRSR core is in line with the Ministry of Corporate Affairs’ (MCA) Report of the Committee on Business Responsibility Reporting, which suggested the implementation of “BRSR Lite”’ with an aim to familiarise unlisted and small listed entities with the standards of sustainable reporting. BRSR Core is a pared down version of BRSR Comprehensive as it does not require detailed disclosures pertaining to ESG and comprises limited parameters. It is thus conducive to the implementation of the framework by such small entities in the initial phase.
First, the transactional threshold poses a risk of excluding upstream or downstream partners characterised by low transactional values and significant environmental or social impact. For the purpose of disclosures, a value chain of a listed entity includes its top upstream and downstream partners which collectively comprise 75% of its purchases/sales by value respectively. However, such a transactional threshold may lead to the exclusion of an upstream or downstream partner which has a considerable environmental or social impact but entails relatively lower transaction value. Thus, disclosures may not be capable of reflecting any environmental or social malpractices of such partners with insubstantial transactional value.
Secondly, the present ESG disclosures for value chains are based on the comply-or-explain basis, which may undermine compliance. Comply-or-explain approach refers to a regulatory regime of corporate governance which necessitates voluntary compliance with a given provision of a governance regime and requires disclosure of reasons for non-compliance, if any. The success of comply-or-explain presupposes the presence of several institutional conditionssuch as accountability and transparency of financial operations and wherewithal and incentives of shareholders to evaluate corporate behaviour, among others. However, the development of such conditions is likely to entail a protracted period of time and may present a problem in emerging market economies. Reportedly, less than 40% of the top 500 listed entities possess any framework of sustainability reporting, notwithstanding the compulsory implementation of BRSR since 2022-23. Difficulty in enforcing compliance coupled with cursory explanations furnished by entities for non-compliance are likely to render the approach inadequate. Thus, the efficacy of comply-or-explain in its current form is manifestly questionable.
Thirdly, the framework predominantly focuses on the fulfilment of limited parameters under the BRSR Core, marginalising the significance of primary BRSR disclosure. Presently, the listed entities are required to make disclosures for their value chain in accordance with the BRSR Core. SEBI’s decision to introduce the BRSR Core is in furtherance of enhancing the reliability of ESG disclosures, for which the listed entities will require reasonable assurance. However, the mandate only fortifies the BRSR Core parameters and makes them more reliable instead of the entire BRSR disclosure. Such a measure is likely to force the entities to prioritise fulfilling the BRSR Core parameters as they might perceive it to be a portrayal of their commitment to ESG compliances without necessarily addressing the broader parameters under the BRSR disclosure. Thus, the mandate with the BRSR Core is likely to breed distraction instead of enhancing the reliability of entire ESG disclosures.
Fourthly, the ineffectiveness of a “one-size-fits-all” approach has surfaced again as entities have to consider a wide array of small businesses and cater to different industry specific ESG frameworks pursuant to their inclusion in the value chain disclosures. While small businesses might be ready for compliance, their lack of technical competency and familiarity acts as an impediment to the reliable disclosure. Since the onus of comprehensive ESG disclosures is on the listed companies, it burdens them with the responsibility to ensure cooperation and participation of value chain partners in effective reporting on sustainability. Based on the recommendations by Taskforce for Climate-related Financial Disclosures, the European Union (EU) is transitioning from a “one-size-fits-all” approach towards a tailored strategic response, enabling companies to disclose information according to the nature of their business, considering their size and complexity. The transition will aid value chain partners in collecting data and disclosing information pertinent to their businesses and will ease the cooperation between them and listed entities in the final disclosure process. Further, such a change will yield better results as observed in the KPMG New Zealand’s Survey of Sustainability Reporting, indicating improvement in the quality of sustainability information reported from 69% in 2017 to 74% in 2020.
Fifthly, data collection and processing may pose a challenge in the process of disclosure of information. Owing to a diverse set of parameters, there is a likelihood of incorporation of different modes of data collection and processing by value chain partners, resulting in challenges for the listed entities in obtaining the data for all KPIs. Due to the presence of a multitude of value chain partners being subject to the disclosure regulations, it can be arduous to monitor and obtain “third-party endorsed data” from them.
Suggestions and Conclusion
Although the execution of the framework faces potential challenges, there are certain practicable measures that can be undertaken in order to reinforce and ameliorate the implementation of the framework in its full rigour. In order to streamline the approach of comply-or-explain and to avoid “tick-the-box” compliance, increased supervision and regulatory enforcement must be adopted to track and tackle inadequate or cursory explanations for non-compliance. As of now, reports are to be filed in XBRL format, which is machine-readable. Mandating the reports to be prepared in iXBRL, which is both human and machine-readable allows entities to efficiently convey and compare reported information by utilising consistent tags, aiding better analysis of reports filed by entities. It also simplifies the process of report filing as it entails both human-readable and machine-readable formats in a single document, as opposed to separate filing of documents required by XBRL. Use of digital tools such as Nossa Data can provide a centralised database for collecting, analysing and sharing the data. It also mitigates any errors in the data processing and ensures accuracy and reliability. Its use of artificial intelligence in materiality mapping aids the analysis of a multitude of reports and comparison of performances to improve key issues for a specific business.
Whilst the strides taken by SEBI towards bolstering ESG compliance among listed entities are commendable, it is essential to acknowledge that certain issues in the current framework warrant immediate attention. The positive aspects of the regulatory framework, such as enhanced transparency and inclusion of BRSR Core so as to simplify the process of reporting for small and inexperienced entities demonstrate SEBI’s commitment to mould environmentally and socially conscious corporate entities as a stepping stone for achieving a responsible corporate sphere. Embracing a nuanced and adaptable approach that considers the diverse nature of businesses and value chain partners will ultimately contribute to the success and effectiveness of ESG disclosures, empowering entities to align with the global ESG disclosure standards.
– Avani Hegde & Praneel Panchagavi