[S Vishnu Ameya is a B.A., LL. B (Hons.) graduate from Damodaram Sanjivayya National Law University, Visakhapatnam]
In recent years, disclosure of the environmental, social and governance (ESG) practices of a company have gained significant attention from investors, regulators, and stakeholders worldwide in building reputation, trust and managing risks. However, the question arose, whether such disclosures be limited to the company itself in isolation or should it extend to the value chain of the company as well? In this regard, the Securities and Exchange Board of India (SEBI) recently issued a consultation paper in May 2024, wherein the expert committee recommended re defining value chain partners as well as some relaxations in the disclosure requirements in the Business Responsibility and Sustainability Report (BRSR) to facilitate Ease of Doing Business (EODB). The present post presents a critique of the recommendations along with some suggestions.
Value Chain Integration in the BRSR Disclosures
A company’s value chain comprises the entire value addition components of the company ranging from procurement of raw materials and services to the end distribution and sale of offerings. It transcends beyond a company’s direct operations and encompasses the company’s upstream (purchase) and downstream (sale) activities and areas incidental to them. Therefore, forming a key area in the overall sustainability and ESG related aspects of the company.
In May 2021, SEBI amended regulation 34(2)(f) of the SEBI (LODR), 2015 by introducing the BRSR, mandating top 1,000 listed entities by market capitalization to file BRSR as part of the annual report. The BRSR was introduced in furtherance of having quantitative and standardized disclosures on ESG parameters to facilitate comparability across sectors, companies and time. Subsequently, the said regulation was amended in June 2023, by incorporating a reasonable assurance on the BRSR core attributes (a subset of the BRSR format) and a value chain disclosure for the BRSR core attributes. The BRSR core consists of Key Performance Indicators (KPIs) based on nine ESG attributes set out in the original BRSR reporting format. These attributes range from greenhouse gas, water and energy footprint, embracing circularity, enhancing employee well-being among others. Further, to enable a more holistic view of a company’s ESG performance and its sustainability footprint, SEBI in July 2023 vide a master circular introduced BRSR Core framework for assurance and ESG disclosures for the value chain. The above requirements apply to the top 250 listed entities by market capitalization from FY 2024-2025. Under the said amendment, such listed entities must disclose BRSR core assurance and ESG disclosures for the value chain encompassing the top upstream and downstream value chain partners cumulatively comprising 75% of the total purchases and sales respectively by value attributable to its business on a “comply or explain” basis.
The said amendment created a ripple effect by bringing in unlisted companies, MSMEs, which form part of the said listed entities’ value chain under the scope of ESG reporting and accountability. This effectively called for a collaborative approach between the value chain partners and the said listed entities by incorporating a variety of mechanisms like enhanced due diligence, clauses in supply as well as distribution contracts, managing operational and reputational risks, monitoring mechanisms and control systems to ensure compliance and sustainability.
Expert Committee Views on Re Defining Value Chain Partners and Disclosures in the BRSR
The Committee heading consultation paper pertaining to BRSR issued by SEBI, noted that in the FMCG, Tech, Chemicals and in the Industrial Machinery sectors, the total number of value chain partners cumulatively covering 75% of purchases and sales (by value) went into hundreds and in some cases thousands in number. This meant that the listed entity had to perform- capacity building & training, increased monitoring, mapping and data collection of its value chain partners thereby causing an adverse impact in terms of cost burden and viability in compliance. To remedy this, the committee suggested to redefine value chain partners to encompass the upstream and downstream partners individually comprising two percent or more of the listed entity’s purchases/sales (by value) respectively. The committee also recommended “voluntary” disclosures approach in place of “comply or explain” approach for the value chain disclosures in the BRSR.
Cross Jurisdictional Perspectives on Value Chain Disclosure in Sustainability Reporting
European Union: On 5 January 2023, the Corporate Sustainability Reporting Directive (CSRD) came to force with an objective to modernize and strengthen the reporting requirements in relation to ESG information. The said directives make it mandatory for large companies, SMEs as well as non-EU companies if they generate over EUR 150 million in the EU market to make sustainability and ESG related disclosures of their “material” value chain partners.
The draft ESRS-1 (European Sustainability Reporting Guidelines), in relation to CSRD applies the standard of double materiality with two dimensions, namely: financial materiality and impact materiality. The ESRS pertains to ESG disclosure aspects in relation to Workers (Social) and climate change & pollution (Environment) across the Value chain. A sustainability aspect is financially material if it triggers financial effects, i.e., generates opportunities or risks that influence or may influence the future cash flows and the enterprise value of the undertaking.
Impact materiality pertains to the undertaking’s actual or potential, positive or negative impacts caused by or contributed to by the undertaking in relation to its operations, products, and services throughout its value chain. Such an impact must relate to the environment or people in relation to ESG parameters either negatively or positively on a long term or on a short-term time horizon. Negative impact is formed based on the sustainability due diligence process defined in the United Nations (UN) Guiding principles on business and human rights and the OECD guidelines for Multinational Enterprises. The severity of a negative impact and the materiality of a positive impact is based on the scale, scope, likelihood, and irremediable character of the impact. It is pertinent to note that CSRD is being implemented in a phase wise manner based on the size of the undertakings and the ESRS-1 (standard of materiality) is yet to be implemented.
United States: The Securities Exchange Commission (SEC) in March 2022 proposed climate-related disclosure requirements for the Value Chain to SEC registrants on similar lines with the double materiality approach as endorsed by the CSRD. The said proposal required extensive disclosure of climate-related financial impacts in the value chain.
Analysis of the BRSR and Way Forward
Firstly, the assurance framework and ESG disclosures in the annual report for their value chain is currently applicable only to the top 250 listed entities by market capitalization (FY 2024-2025). It is pertinent to note that the upstream and downstream activities of these listed entities involve huge cash flows and usually are high value transactions. Therefore, the recommendation pertaining to BRSR assurance and ESG disclosures for the value chain in relation to the value chain partners individually forming two percent or more in the respective value chain activity is a welcome step at least at an initial level. This is because the value chain partners who hold financial significance in the value chain have now come under the purview of sustainability reporting. In one way, such a move facilitates a more collaborative approach between such listed entities and their major supply chain partners as well as distributors, thereby creating a ripple effect throughout the value chain eventually.
Further, like the CSRD and ESRS-1 as being adopted by the EU, the assurance framework and ESG disclosures under the BRSR in due course of time must be extended to such value chain partners causing material impacts on the ESG aspects of such listed entities. This would further add to sustainability reporting as there may be value chain partners who may not have a significant financial impact but may significantly affect ESG aspects in the value chain of such listed entities. Since the scale of materiality is based on factors like severity, scope, likelihood, and irremediable character of its impact on ESG, such a requirement would act as a mechanism to decipher the key value chain participants with respect to the overall ESG aspects of such listed entities. Such a requirement would also facilitate access to capital from global investors. Further, it will aid listed entities that have an international presence, by ensuring that India’s ESG requirements are consistent with the regulatory requirements abroad.
Secondly, the committee recommendations in very general terms state “value chain partners individually.” In this regard, it is suggested that even the subsidiary companies, the holding company as well as associate companies of the value chain partner be considered when computing the value involved in the applicable activity as group structures may be used as a leeway to avoid assurance and ESG disclosures.
Thirdly, “voluntary disclosure” approach as proposed by the committee may lead to adverse consequences as regulators world-wide are working in furtherance of mandatory ESG disclosures one way or the other. This could give rise to a perception that India is a laggard in ESG regulations, thus disincentivizing global investors. Further, entities may choose to not disclose, thereby contradicting the very principle of transparency and disclosure as envisaged by the listing regulations (LODR). Therefore, the “comply or explain” approach must be retained to strike a proper balance between ESG disclosures and EODB.
Conclusion
The recommendations in one way seek to institutionalize ESG disclosures by first bringing value chain partners who are significant financially in the value chain under the ambit. However, the regulations must look beyond individual body corporate level of the participant and must also consider the involvement of the participant’s group structure in the value chain. Further, the disclosure requirements must, in due course, transcend beyond financial parameters and must consider parameters that impact the overall ESG aspects as well. Lastly, the disclosure requirements must be on a comply or explain basis to be on par with market practices being adopted globally and to enable sustainability disclosures in true spirit.
– S Vishnu Ameya
