Elevating Corporate Value - The Art Of ESG Integration In Securities And Investment
Author: LawSphereX
Category: Corporate & Insolvency
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ELEVATING CORPORATE VALUE: THE ART OF ESG
INTEGRATION IN SECURITIES AND INVESTMENT J. Sai Vimalananthi, Graduate from Symbiosis International University & CS Finalist from
ICSI
ABSTRACT
This paper aims to analyze the critical importance of incorporating the environmental, social and governance related factors to be able to survive in the corporate landscape. ESG consideration is a two-way street, where the investors play a significant role as the companies themselves. Their responsible thinking, due diligence and informed decision-making will help set the entire cycle on the right track. As investors begin to recognize that what the company in which they invest in does, is what their fund does, they are encouraged to think beyond mere profit. This shift enables them to direct their investments towards causes that address broader concerns, fostering responsible and sustainable corporate growth.
All corporate players must demonstrate responsibility towards the environment, society, and legal compliance, while prioritizing ethics, to dispel the stigma of being labeled as mere "money-making machines. ". The corporate entities and the investors by shaping their investment decisions can evolve into forces driving positive change and contributing to a sustainable and equitable future. The paper opens with an introduction that traces the evolution of ESG, from the era of ethical and religious investing to the development of legislation mandating ESG considerations. The chapter on ‘ESG Securities’ delves into the intricacies of green securities and the emerging sustainability-linked securities, analyzing various regulations and circulars issued by the regulators.
The final chapter explores how ESG investments influence corporate governance, encouraging companies to become environmentally conscious, socially responsible, and compliant with legal and ethical standards.
INTRODUCTION
ESG investment is an investment strategy with dual objectives: achieving financial performance and fulfilling investors' ethical, social, and environmental values. 1 As investors increasingly recognize the importance of these factors, companies must give equal attention to environmental, social, and governance (ESG) domains. The rapidly growing track record shows that companies with responsible practices not only attract like-minded investors but also have a greater potential for sustainability. ESG investing involves directing capital into securities that represent a cause beyond mere profit, reflecting a commitment to the world beyond the company itself. This investment approach requires decision-making that carefully considers environmental, social, and governance factors alongside traditional financial metrics.
Investors hold diverse values, making it neither plausible nor practical for companies to meet all of them. Moreover, there are only a few business operations where ESG considerations may seem irrelevant. Therefore, it is sufficient for companies to focus on effecting change within their specific business domain, and ideally, in their day-to-day operations. This can be achieved by identifying areas that require attention or improvement in alignment with ESG principles. In other words, the company shall prioritize what is material to itself, given the industry or special circumstances because the interests and motivations of investors shift with time and changing circumstances. Considering ESG factors while investing is also referred as ‘Socially responsible investing’2, ‘impact investing’, ‘sustainable investing’.
The irony is that the impact of the ‘SRI’ or the ESG investing is evaluated in terms of financial performance. Financial metrics are given more attention without any change in the methodology of evaluation or any proven research or conceptual framework relating to the motivations of SRI investors, non-financial performance etc. 3 1 Paolo Fiorillo & Gianluca Santilli, The Influence of Shareholder ESG Performance on Corporate Sustainability: Exploring the Role of Ownership Structure, FIN. RES. LETTERS, 67, (2024).
2 B.D. Johnsen, Socially Responsible Investing
A Critical Appraisal, BUS ETHICS 47, (2003).
3G. Capelle-Blancard & S. Monjon, Trends in the Literature on Socially Responsible Investment: Looking for the Keys Under the Lamppost, BUS. ETHICS EUR. REV., 21 (2012).
ESG investment involves collection and analysis of data relating to the business practices of an issuer and using the outcome of such an analysis in making an informed investment decision. ESG investment operates with the belief that both the investors and the society at large will benefit. 4 The major benefit of ESG consideration is that it enables the investors to analyse the company’s status quo and performance in a holistic manner and not just restricted to the profitability, this encourages the investors to make vigilant investment decisions. It provides awareness and instigates realization of the purpose served by their fund, as it depends on how the issuer operates.
ESG investment contributes to the sustainability pathway in a dual manner; primarily, socially responsible investors encourage the businesses to follow sustainable practices in true letter and spirit; Secondly, directing their savings into securities with greater cause ultimately leading to the betterment of the society and the corporate world. Moreover, the socially responsible investors have the potential to influence the legislative agencies, driving amendments with an aim to transform the corporate world into a force that focuses on environmental stewardship, social responsibility and strong governance practices. EVOLUTION OF ESG INVESTING The principles of ESG have always been factors shaping the investment decisions in the name of ethical beliefs and thinking.
However, the concept of ethical investing meant excluding such industries from the portfolio which act against morality, values, or ethics. 5 For instance, people have refrained from investing in companies such as tobacco manufacturers. Sharia law professed by Muslims prohibited investments in weapons. 6 First entities mainstreaming ethical considerations can be traced back to the trusts constituted by Quakers and Methodists in the nineteenth century. 7 Since then rapid focus was directed towards sustainability as the realization of the severity of climate change started hitting, leading to investor awareness. Thereafter, in the 1960’s ESG investment was initiated in the form of socially responsible 4 Emiel van Duuren, Auke Plantinga & Bert Scholtens, ESG Integration and the Investment Management Process: Fundamental Investing Reinvented, J. BUS.
ETHICS, 138 (2016) 5Staci West, The Evolution of Ethical Investing, FUNDCALIBRE (2023). 6Orsagh, Allen, Sloggett, & Dehman, ESG Integration and Islamic Finance: Complementary Investment Approaches, CFA INSTITUTE, (2019). 7The History of Sustainable Investing, MORNINGSTAR (2020). investment making diligent decisions by eliminating any investment into activities that have an adverse impact on the society. In India, Corporate Social Responsibility evolved from mere donations to a strategic undertaking by companies with the mandate of CSR under Section 135 of the Companies Act,
2013. CSR is presently the strategic tool for integrating all the sections of the society who were
earlier neglected in the process of development. The Principles of Responsible Investment is one of the world's leading guidelines advocating responsible investment which aids investors across the globe in incorporating ESG considerations into their investment decisions. It provides a framework to assess if the investments and financial decisions are sustainable and responsible. 8 ESG standards gained predominance followed by the release of these principles, which at present has over 2900 signatories and 60 sustainable investment funds for investors. 9 Investors began hunting for resiliency post the impacts caused by the Pandemic, and this directly led them to ESG investment. “Global ESG fund assets reached about $2. 5 trillion at the end of 2022, up from $2. 24 trillion at the end of the third quarter”10. This 12% growth is almost double the global funds growth rate.
11 Further, The Capital Group’s ESG Global Study,
2023 finds that the investment professionals improvising ESG approach has hiked to 90%.12
According to Bloomberg's research report, ESG assets exceeded 35 trillion USD in 2020, reached 41 trillion USD in 2022, and are projected to surpass 50 trillion USD by 2025. Additionally, 80% of investors factored in ESG considerations, with 54% believing that ESG factors contribute to long-term performance.13 Currently, investors have started marching towards funds that are aligned with their values and address global crises, to start with by complying with regulations brought into effect in this regard. This shift is particularly evident with youngsters who are prioritizing ESG goals, even if it means compromising short-term profits. As a result, companies are not only proactively 8Building a Sustainable Future: ESG Business Handbook, The AIRE Centre & UNDP (2023).
9 West, The Evolution of Ethical Investing.
10 Morningstar, Global Sustainable Fund Flows
Q4 2022 in Review (2022).
11 Brian Baker, CFA, ESG Investing Statistics 2023, BANKRATE (2023).
12 ESG Global Study, 2023, CAPITAL GROUP (2023).
13 ESG May Surpass $41 Trillion Assets in 2022, But Not Without Challenges, Finds Bloomberg Intelligence, BLOOMBERG INTELLIGENCE, (2022). developing and introducing projects and funds that promote sustainability, but are also taking it a step further by engaging in ESG reporting to showcase their commitment to these goals. This approach enhances their reputation and profitability, leading to higher returns on ESG funds and positioning them to perform better in the long run due to their inherent resilience compared to conventional, profit-focused investments. ESG SECURITIES The journey of ESG securities began with SEBI's issuance of the 'Concept Paper for Issuance of Green Bonds'. 14 In February 2022, the government's plan to issue Sovereign Green Bonds was announced by the Finance Minister, aiming to finance public sector green projects.
15 These bonds are intended to generate funds for initiatives that contribute to reducing the carbon intensity of India's economy. This initiative aligns with India's targets set in its Nationally Determined Contributions (NDCs), first issued in 2015 and updated in 2022, as part of its commitment to the United Nations Framework Convention on Climate Change (UNFCCC) and the Paris Agreement. 16 The Intended Nationally Determined Contribution (INDC) document highlights the critical need for financing to meet its climate goals. It estimates that at least USD 2. 5 trillion will be required for climate change projects by 2023. 17 The Government of India has raised Rs. 16,000 Crore through the issuance of sovereign green bonds with its debut issue of Rs 8000 crore on January 25, 2023 and a further issue on February 9, 2023.
18 “The funds generated were duly allocated to Ministries/Departments such as New and Renewable Energy, Environment, Forests and Climate Change, Housing and Urban Affairs, Railways etc. ”19 The sovereign green bonds underscore India’s Commitment towards enhancing its renewable energy generation and alleviating the carbon intensity by developing and financing schemes and projects for renewable energy and transition into electric transportation.
14 Concept Paper for Issuance of Green Bonds, Securities and Exchange Board of India (Dec. 3, 2015).
15 Farah Imrana Hussain & Helena Dill, India Incorporates Green Bonds into Its Climate Finance Strategy, WORLD BANK.ORG (June 12, 2023) 16 Government of India, India’s Updated First Nationally Determined Contribution Under Paris Agreement (Aug.
2022) (submission to UNFCCC).
17Government of India, India’s Intended Nationally Determined Contribution: Working Towards Climate Justice, https://www4.unfccc.int/sites/submissions/INDC/Published%20Documents/India/1/INDIA%20INDC%20TO% 20UNFCCC.pdf
18 Ministry of Fin., Year Ender 2023
Department of Economic Affairs, PIB (2023),
19 Id
Breaking Down SEBI’s NCS Regulations: Green Debt Securities: Green bonds operate identical to any other debt instrument, except that the proceeds generated from its issue are earmarked to be spent on projects classified as ‘green projects. Regulation 2(1)(q) of the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 defines “Green Debt Security as a debt security issued for raising funds subject to the conditions as may be specified by the Board from time to time, to be utilized for project(s) and/ or asset(s) falling under any of the following categories:
1. Renewable and sustainable energy (e.g., wind, bioenergy, clean technology).
2. Clean transportation, including public transit.
3. Climate change adaptation (e.g., resilient infrastructure, climate observation and
warning systems).
4. Energy efficiency, such as green buildings.
5. Sustainable waste management (e.g., recycling, waste-to-energy).
6. Sustainable land use, including forestry, afforestation and agriculture.
7. Biodiversity conservation.
8. Pollution prevention and control (e.g., air emission reduction, waste recycling) and
sectors falling under the India Cooling Action Plan launched by the MoEFCC.
9. Circular economy practices (e.g., reusable, recyclable materials) and Eco-efficient
products.
10. Blue bonds for sustainable water management and maritime sectors.
11. Yellow bonds for solar energy and related industries.
12. Transition bonds for operations aligning with India’s climate commitments (INDCs).
13. Any other category specified by the Board.”20
Further, Regulation 26 states that the issuer of green debt securities shall adhere to the conditions issued by the board. 21 Chapter IX of the NCS Operational Circular of SEBI revised as on February 06, 202322, to align with the Green bond principles by ICMA which are recognised by IOSCO, outlines the initial and continuous disclosures requirements for issuers of green debt securities including the mandatory appointment of third party certifier and the issuer’s responsibilities. Initial Disclosures Requirements: The initial disclosure to be made by the issuer of the green debt securities includes the following: ● Sustainability objectives of the proposed issue of the securities ● Decision making process followed to determine the eligibility criteria of the project or asset in which the proceeds of the proposed issue are to be expended, in brief.
The constituents of this disclosure shall be (1) the process put in place to determine the factors that enable the project to fit within the scope of ‘green debt securities’ as enlisted in Regulation 2(1)(q) of the NCS Regulations; (2) The attributes making a project or asset qualified for the proceeds to be expended on; (3) The details of Indian and global taxonomy, green standards or certifications, if any and the association of the project or the asset therewith; (4), In case of transition bonds, the details of how the objective of the bonds corroborate with the Indian Nationally Determined Contributions. ● Details of the process implemented to monitor the deployment of the funds raised.
● Details of the project or assets or areas in which the proceeds of the issue of green debt securities is proposed to be deployed (including refinancing) 20SEBI (Issue and Listing of Non-Convertible Securities), 2021, Regulation 2(1)(q). 21SEBI (Issue and Listing of Non-Convertible Securities), 2021, Regulation 26. 22Securities and Exchange Board of India, Revised Disclosure Requirements for Issuance and Listing of Green Debt Securities, SEBI/HO/DDHS/DDHS-RACPOD1/P/CIR/2023/023, issued on Feb 6, 2023.
● Details of allocation of the proceeds between financing and refinancing projects and an indicative estimate of the same. ● Details of the methods in which the unutilized proceeds are intended to be placed (on temporary basis) until its utilization. ● Details of the potential risks and the mitigation strategies associated with the proposed project in which the proceeds are intended to be deployed. ● The issuer shall appoint a third-party certifier/reviewer to evaluate and certify all processes involved after the issuance including impact reporting, and internal monitoring on ‘comply or explain’ basis for a period of two years.
Continuous Disclosure Requirements: An issuer with listed green debt securities shall make the following additional disclosures with its annual report and financial results: ● Utilization of Proceeds: Disclose the utilization of proceeds as tracked by the issuer’s internal process. This shall be verified by an external auditor, confirming the tracking method and fund allocation towards the project(s) or asset(s) financed by the green debt securities. ● Unutilized Proceeds: Provide details of unutilized proceeds, including the temporary placement or use of unallocated and unutilized proceeds from each ISIN of the green debt securities issued. ● Annual Report Disclosures: Include the following: ➔ A list of project(s) or asset(s) where proceeds have been allocated, with a brief description and disbursed amounts.
➔ Qualitative and, if feasible, quantitative performance indicators of the environmental impact. If quantitative measures are not available, reasons must be disclosed.
➔ Methods and key assumptions used for performance indicators and metrics. ➔ Details on the implementation of the mitigation plan for social and environmental risks, as disclosed in the offer document. ● Impact Reporting: Provide project-specific environmental impact reports, including reporting standards or taxonomies used. ● BRSR Elements: Disclose major elements of Business Responsibility and Sustainability Reporting (BRSR) Appointment of Third Party Reviewer/ Certifier: The issuer shall appoint a third-party certifier/reviewer to evaluate and certify all processes involved after the issuance including impact reporting, and internal monitoring on ‘comply or explain’ basis for a period of two years. Issuer’s Responsibilities: The issuer shall: ● Determine and maintain a standard process of decision making to ascertain the ongoing eligibility of the project or asset.
● Ensure that the intended objectives of the projects or assets are being met. ● Deploy the proceeds solely on the intended purpose as stated in the offer document ● Ensure the circular enumerating the ‘Do’s and Don'ts relating to green debt securities to avoid occurrences of greenwashing’23 is complied with. There are separate circulars and legislations presenting the additional disclosures and other requirements to be fulfilled for the issued of transition bonds and issue of green debts as 23Securities and Exchange Board of India, Dos and don’ts relating to green debt securities to avoid occurrences of greenwashing, SEBI/HO/DDHS/DDHS-RACPOD1/P/CIR/2023/0230, issued onFeb 03, 2023. municipal debt securities as per the circular titled ‘Additional requirements for the issuers of transition bonds’24 and the ILMDS Regulations of SEBI25 respectively.
Sustainability - linked bonds On August 16, 2024, the Department of Debt and Hybrid Securities of SEBi issued a ‘Consultation paper on expanding the scope of sustainable finance framework in the Indian Securities Market’26. This paper makes a reference to one of the major initiatives of the FY- 2023-24 that is to enhance the ease of doing business and reduce the compliance cost within the financial sector. In pursuit of this a working group was constituted to review the provisions of the SEBI (issue and Listing of Non-Convertible Securities) Regulations, 2021. Widening the scope of Sustainable finance securities by way of redefining ‘Green debt securities’ as ‘Sustainability-linked securities’ recognising that the former seems to be limited to environmental sustainability focused securities.
This wider spectrum would encompass ‘social bonds’, ‘sustainability-linked security’, ‘sustainability bonds’ and ‘green debt securities’ collectively referred to as ESG Debt Securities. The paper also highlights the potential for amending the NCS Regulations to incorporate the aforementioned additional securities, ensuring alignment with relevant international regulations. These may include the principles set forth by the ICMA for Green Bonds, Social Bonds, Sustainability Bonds, and Sustainability-Linked Bonds, the Sustainability-Linked Loan Principles of the Asia Pacific Loan Market Association, and the Climate Bond Standard by the Climate Bond Initiative. Furthermore, the paper outlines the proposed functions of the third-party certifier/reviewer, encompassing roles such as providing a Second Party Opinion, Verification, Certification, and Scoring/Rating.
It concludes by raising the question of whether ESG rating providers should also be permitted to conduct such reviews. 27 24Securities and Exchange Board of India, Additional requirements for the issuers of transition bonds,SEBI/HO/DDHS/DDHS_Div1/P/CIR/2023/66, issued on May 04, 2023 25SEBI (Issue and Listing of Municipal Debt Securities) Regulations, 2023 26SEBI, Department of Debt and Hybrid Securities, Consultation Paper on Expanding the Scope of Sustainable Finance Framework in the Indian Securities Market (Aug. 16, 2024). 27Id.
CORPORATE GOVERNANCE INFLUENCER
Integrating ESG into not only the corporate governance framework but also into risk management frameworks has become crucial for preventing, identifying, assessing, and mitigating potential ESG risks. With the rise in environmental and social issues, investors have become increasingly demanding and conscious, making it essential for companies to embed ESG standards into their day-to-day operations. Companies must establish systems and procedures to proactively identify ESG risks and opportunities, taking measures to mitigate threats and capitalize on opportunities. Today's investors prioritize long-term sustainability alongside profit metrics, directing their funds toward companies with the resilience to thrive in the market over time. To achieve this sustainability, companies must take meaningful initiatives within the ESG landscape.
Only those with robust ESG principles are capable of withstanding the adverse impacts of various crises—a trend that has been clearly demonstrated and accelerated since the COVID-19 pandemic. 28 Companies that adhere to strong corporate governance practices are likely to experience higher returns, driven by enhanced brand reputation and increased customer loyalty. A prime example is Tata Group, which, during the pandemic, provided accommodation at Taj hotels for medical staff and frontline workers. 29 Such initiatives not only demonstrate corporate responsibility but also foster deep brand loyalty, reinforcing the connection between ethical practices and longterm success. ESG investment is often referred to as sustainable investment as the companies which consistently adhere to ESG practices tend to evolve into a sustainable organization.
30 It is crucial for organizations to start addressing the ESG issues proactively, rather than merely perceiving them as risks. It is essential for the Boards to take responsibility for integrating ESG into governance frameworks and fully understand the benefits of ESG and be aware of their 28Min Gao & Xiulin Geng, The Role of ESG Performance During Times of COVID-19 Pandemic, SCI. REP. 14 (2024).
29 Standing with COVID -19 Warriors, TATA, July, 2022.
30Yingying Zhang, Dongqi Wan & Lei Zhang, Green Credit, Supply Chain Transparency and Corporate ESG Performance: Evidence from China, FIN. RES. LETTERS, 59, (2024). roles and duties in tackling the challenges effectively . 31 ESG Strategy not only attracts investment, but also helps attract and retain talents, boosts profitability through customer loyalty, fosters healthy relationships with government authorities by reducing non-compliances and unfavorable litigation32. This approach enables companies to have fruitful business relationships, as all stakeholders including customers, suppliers, government authorities, investors, creditors and the surrounding community are more inclined to contribute to and support those companies which demonstrate genuine care and offer opportunities for collective growth.
Investors have increasingly begun to accommodate ESG related funds portfolios recognising positive impacts on the environment and the society at large as well as their resilience33 and stability34 at times of crisis compared to the conventional portfolios and the substantial reduction in the investment risks. This shift has led to more rigorous scrutiny of the governance framework and policies, indirectly encouraging companies to initiate actions in the ESG arena. While formulating an ESG strategy may seem challenging for formulating, a well-crafted and effectively implemented plan can yield benefits that extend beyond profits. 35 SEBI has mandated BRSR reporting for the top 1,000 companies since FY 2022-23, with reasonable assurance of BRSR core required from FY 2025-26.
36 Additionally, in countries like Hong Kong and Singapore, listed companies are required to file ESG reports annually. This rapid integration and enforcement highlight the growing significance of ESG in the global corporate landscape.
CONCLUSION
It is apposite to conclude that ESG is emerging to be a significant force influencing the investments on a large scale in India. While it may not be advancing as rapidly as in other 31Pinheiro, Bandeira, Berhorst, Toaldo & Segatto, Exploring the relationship among ESG, innovation, and economic and financial performance: Evidence from the energy sector, INT. J. ENERGY SECTOR. MANAG.,18. 32Hua Zhang, Huaqing Zhang, Li Tian, Shengli Yuan & Yongqian Tu, ESG Performance and Litigation Risk, FIN. RES. LETTERS, 63, (2024) 33Haijun Wang, Shuaipeng Jiao & Chao Ma, The Impact of ESG Responsibility Performance on Corporate Resilience, INT’L. REV. ECON. & FIN., 69, (2024). 34Ricci, Ornella, Santilli, Scardozzi, & Lopes, ESG resilience in conflictual times, RIBAF, 71, (2024). 35Hsu, Tzu-Jo, & Huang, On the resilience of US ESG stocks: Evidence from the COVID-19 market crashes, ECO. LETT., (2024).
36Securities and Exchange Board of India, BRSR Core - Framework for assurance and ESG disclosures for value chain, SEBI/HO/CFD/CFD-SEC-2/P/CIR/2023/122, issued on July 12, 2023 economies, it is nonetheless captivating investors prompting them to prioritize ESG factors over returns as they come to realize that their funds are intertwined with the unfavorable activities committed by corporations. However, the advancements in the ESG landscape— including the emergence of ESG rating agencies, mandatory ESG ratings like BRSR reporting, and steady progress in fulfilling CSR obligations—are promising enough to transform corporate entities into a powerful force for making the world a better place. ESG is a vital component for the sustainable development of any organization.
While Corporate Social Responsibility (CSR) is a significant avenue to achieve ESG goals, it is just one of many strategies. ESG also encompasses initiatives like local procurement, where large corporations source materials from local vendors. This approach not only fosters the development of the surrounding community but also minimizes environmental impact and reduces the time and costs associated with logistics and transportation. Furthermore, ESG now includes comprehensive Diversity and Inclusion efforts, which extend beyond gender to also consider race, as well as investments in employee health and safety, including mental well-being. Companies must also establish robust whistleblower protection mechanisms to ensure resilience against retaliation. Adherence to strong ethical standards is essential for companies committed to ESG principles.
Moreover, ESG reporting needs to surpass its role as a mere corporate disclosure requirement and evolve into a tool that demonstrates a company’s responsibility and commitment in making the world a better place. It should reflect a genuine dedication to societal and environmental impact and not focus merely on corporate or shareholder value creation. On the other hand, it is crucial for investors to make informed decisions by thoroughly analyzing all relevant aspects and choosing investments in companies that align with their values and ESG goals. As discussed in the paper, the ESG securities landscape is composed for significant development, both in terms of regulation and performance. Investors should consider incorporating ESG-focused investments into their portfolios for enhanced stability, sustainability, and profitability.
ESG is the new normal, poised to revolutionize global business practices, bringing widespread benefits to both the business community and the world at large.