US, Asian countries adopt ESG in business, investing style; here’s all you need to know about ESG investing

By Arjun Yash Mahajan

ESG – Environmental, Social and Governance, are three words that have gained importance world over. ESG is still at a nascent stage in India and companies, fund management and broking are now adopting these three words which have a vast scope. Europe (EU) led the way in ESG adoption and only in the last few years USA and few Asian countries are adopting in their business and in investing style. Since 2014, over 2500 dedicated ESG funds have been launched which manages over ~US$1 trillion. In Indian context, there are only a handful of fund houses that have launched dedicated ESG funds, however, this is surely set to change in the next couple of years.

ESG is best explained when all the three alphabets are taken independently. When we look at E – Environmental aspects, one should focus on climate change carbon emissions, air & water pollution, biodiversity, deforestation, energy efficiency, waste management and exposure to arms. These are few key parameters that need to be carefully considered when looking at a company’s E exposure and the E score. To be specific, Materiality of E needs to be understood depending on the sector and stock under consideration. For a company into mining, E score must be a key focus, as not only mining causes environmental damage, but also its use in power generation and other such areas is also adding to the environmental damage. Similarly, when one looks at S – Social aspects, one should focus on customer satisfaction, data protection & privacy, gender diversity, employee engagement, community relations & service, human rights and labor standards. 

Social aspects in Indian context are very important and should be a focus point. Investors should give high weight to companies that have a high S score, as it just shows the company or companies in question do really care about society, their own labor while generating profit and shareholder return. Soon investors will start focusing on not only shareholder return but along with it will incorporate Society and Shareholder return. Finally, the word G – Governance, has already attracted focus in India, with companies trying to incorporate it. One key aspect of Governance – Executive Compensation, is still an area that needs more focus and as ESG takes more relevance in investing process, investors, Asset Management companies, Foreign Portfolio Investors (FPI), Venture Capital (VC) and such investors will have to impress upon management to align Executive compensation with that of another key management team. The Chairman, Managing Director alone should not be the biggest beneficiary of abnormal Executive Compensation.

Incorporating ESG in business and companies has to be driven from Top-down. Companies in the west that have incorporated ESG in their business have been successful due to the main fact that their respective CEO took upon themselves to make sure that it is implemented and is made a focus across the organization. It has not only led to the adoption of cleaner and environmentally friendly business processes but has also led to social and shareholder returns. In Canada, one of the Utility companies that was using coal in their process of generating energy, accelerated their transition to initially reduce coal dependence and ultimately took coal out of their entire energy generation process. It reduces the cost of debt, cost of equity, reduced employee turnover, increased employee efficiency and thus increased shareholding return. Similarly, ArcelorMittal, the world’s leading steel and mining company, has committed to reduce carbon emissions by 30% by 2030 and will become carbon neutral by 2050. In both the above examples, the ESG integration in business has been led by top management and the respective CEO, CFO are driving these initiatives under their own watchful eyes. 

Finally, what is driving the integration of ESG in businesses in Europe is the respective governments, central banks support to the industry and companies – European Investment Bank (EIB), with support of the European Commission granted a EURO 75mn loan to Arcelor Mittal for construction of two groundbreaking projects at Ghet, Belgium to considerably reduce carbon emissions by converting waste and by-products into valuable new products, helping to develop low-carbon steel making technologies, in line with EU’s climate objectives.

In conclusion, ESG in India needs to be incorporated not at a snail’s pace but as a priority and this can either be led by the central and state governments working in conjunction with respective industries and companies or by Investors, who can actually drive this by putting pressure on companies and the companies putting pressure on governments to expedite the process by favorable policies, giving grants, subsidies and loans which make it attractive for companies to incorporate ESG. 

(The author is Head – Institutional Business at Reliance Securities. Views expressed are the author’s own.)