[Akshaya Kamalnath is Associate Professor at ANU Law School.
This post is part of the IndiaCorpLaw Blog Symposium on ‘Corporate Law and Climate Change: Indian and Comparative Perspectives’.]
Climate change is one of today’s biggest problems (alongside tech disruptions and inequality). As significant actors in society, corporations too must deal with these big problems and hence corporate law and regulation across jurisdictions seek to find ways to hold corporations to account in order to address these problems. In the context of climate change, one route has been to provide incentives and guidelines to ensure sustainable investment management. A number of countries have taken this route, but here, I will focus on India. This post draws from my recent paper on the topic.
Sustainable Investment Management in India—What, Why, and From Where?
In contrast to countries like the UK, where institutional investors have significant holdings in public companies, in India, controlling shareholders are dominant. This means that rather than simply relying on institutional investors to steer companies, other forms of solutions are required in India. This is true in the context of corporate sustainability as well, and so any regulations targeting sustainable investment management should be viewed alongside the development of the concept of corporate sustainability in India. Therefore, a brief look at both the sui generis ideas of sustainability that have permeated into corporate law and those that have come from outside is useful here.
While ESG is a concept India has slowly moved towards in following the international trajectory, the idea of CSR has not been abandoned. On the contrary, it has been crystallized into a conception of CSR that is unique to India. The CSR provision in the Companies Act, 2013 requires companies of a certain size to annually spend at least two percent of their average net profits generated in the preceding three financial years on CSR activities. This is to be done through a CSR committee. As I have noted in earlier co-authored work, the CSR spending requirement seems to be calling on corporations to engage in nation-building.
Despite having a certain unique idea of CSR, India, in response to the international popularity of sustainability reporting, also adopted a sustainability reporting framework. Initially known as the Business Responsibility Reporting or BRR (which was introduced in 2015), it was later replaced by the Business Responsibility and Sustainability Report (BRSR) in 2021. This was essentially introduced with investors in mind. In 2023, Securities and Exchange Board of India (SEBI), India’s securities market regulator, further issued a circular which identified BRSR Core (or a subset of the BRSR), consisting of certain Key Performance Indicators under nine ESG attributes. In prioritizing these nine attributes, it seems that the underlying principle is again that of nation-building, as seen in the CSR context. The nine attributes are: greenhouse gas footprint, water footprint, energy footprint, waste management, employee well-being and safety, gender diversity in business, inclusive development, fairness in engaging with customers and suppliers, and openness of business. The last attribute specifically targets the issue of related party transactions in India. The top 1000 listed companies in India have to comply with the BRSR Core by 2026-27 and so this discussion is a very important one at present.
Sustainable Investment Management—A Focus on Mutual Funds
While investment management consists of a wide array of fund managers, there has been a focus on mutual funds when it comes to ESG offerings in India. In 2023, SEBI, in response to industry feedback, expanded the ESG offerings that mutual funds were allowed to make. Under this expanded allowance, an ESG category scheme could be launched under one of the following strategies: exclusion, integration, best in class and positive screening, impact investing, sustainable objectives, transition and transition-related investments.
Having set out these strategies, the SEBI Circular on this also stipulates that at least ‘80% of the total assets under management (AUM) of ESG schemes shall be invested in equity & equity related instruments of that particular strategy of the scheme’. Further, the remaining 20 per cent ‘should not be invested in contrast to the strategy of the scheme’. It is further stipulated that ‘an ESG scheme shall invest at least 65 per cent of its AUM in companies which are reporting on comprehensive BRSR and are also providing assurance on BRSR Core disclosures’ and the remaining 35 per cent should be invested in companies with BRSR disclosures. The SEBI Circular on this also sets out disclosure requirements for fund managers offering ESG schemes. First of all, it stipulates that the name of the ESG strategy being followed should be clearly disclosed. Within a year of these regulations being introduced, it was reported that some mutual fund companies notified investors about the change in the name of their offerings, thus allowing investors to better understand how their funds were being managed. Examples include Kotak ESG Opportunities Fund changing its name to Kotak ESG Exclusionary Strategy Fund, and Aditya Birla Sun Life ESG Fund changing its name to Aditya Birla Sun Life ESG Integration Strategy Fund.
With respect to voting, SEBI’s mutual fund regulations require the mutual funds to compulsorily cast votes in respect of all resolutions of their investee companies. Not only this but all asset management companies are required to disclose their voting activity on a quarterly basis, along with the rationale for their voting. In addition to these requirements, the SEBI Circular on Mutual Fund Schemes for ESG investing now adds the requirement that, alongside the rationale for voting, the asset management companies should also disclose ‘whether the resolution has or has not been supported due to any environmental, social or governance reasons’. These enhanced disclosure requirements for ESG schemes became applicable from the 2024 to 2025 financial year.
Mutual funds are also required to provide commentary for ESG schemes. The commentary essentially consists of four discussion points—examples to show how ESG strategy was applied to the fund; case studies showing engagement ‘with portfolio companies with a clear objective of engagement and engagements carried out for exercise of votes’; ‘details on number of engagements carried out in a year, the modes of communication employed, and if any outcomes were achieved in the reporting year’; and ‘annual tracking of ESG rating/score movements in the investee companies’.
There have been measures to address potential greenwashing. Disclosures are required regarding third-party assurance of ‘ESG scheme’s portfolio being in compliance with the strategy and objective of the scheme, as stated in respective’ information documents. Additionally, the fund manager’s board has the responsibility of ensuring ‘that the assurance provider for an ESG scheme has the necessary expertise, for undertaking reasonable assurance’. The board of the fund manager must also certify that the ESG schemes being offered comply with all regulatory requirements, including disclosures. The certification must be made after an internal ESG audit, which also includes stewardship reporting, thus giving the stewardship code a little more bite. Finally, the fund manager should avoid any conflict of interest with the assurance provider.
The third-party assurance requirement in the SEBI Circular on the BRSR Core has been fulfilled in the market by ESG ratings providers (ERPs) as they are known internationally. India became the first jurisdiction to develop a framework for the regulation of ERPs in 2022. Since then, the EU, UK, Singapore, and Japan have also introduced frameworks to regulate ERPs. However, it seems that India is unique in coupling ERPs with ESG fund regulation.
In the Indian market, ERPs were mainly subsidiaries or parent entities of credit rating agencies and research analyst firms. Thus, the Credit Agency Regulations originally issued in 1999 by SEBI were amended in 2023 to address ERP regulations. This drew from the Master Circular on ERP Regulation issued by SEBI in 2023. First and foremost, these regulations require that ERPs must be registered with SEBI, and every time there is a change of ownership of the ERP, the entity has to re-register with SEBI. Amongst the many transparency and disclosure requirements specified in the ERP Regulations, a key requirement is that the ERP must provide a detailed rationale for the rating it has provided for each entity.
The ERP Regulations, coupled with increased categories of ESG offerings, might encourage more confidence in investors because of increased choices in ESG offerings and regulations that aim to prevent greenwashing. The regulations discussed here are relatively new, and even if they have driven away some foreign ERPs because of the heavy compliance burden, they might eventually drive greater confidence in the Indian ESG investment offerings.
Relevance of Some New Global Issues to India
Some points of contention coming up internationally are the backlash against ESG (originating in the USA but spreading beyond as well), and judicial discussion around the fiduciary duties of fund managers and how they might impact ESG investing. The issues are linked, with ESG backlash giving rise to fiduciary duty challenges. None of these have come up in India as of now. Trump-inspired ESG backlash has not arrived in India. Further, while past cases have confirmed that fund managers owe a fiduciary duty to their beneficiaries, this issue has not come up in the context of ESG considerations in investment decisions. One can speculate that if the issue of ESG obligations conflicting with fiduciary duties of fund managers does come up, it will be less controversial in the case of ESG funds since investors already know what they are getting into.
– Akshaya Kamalnath
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