What is ESG and How is it expected to work!

Environmental, Social, and (Corporate) Governance framework emanates from the idea of pushing corporates towards sustainable businesses; responsible and ethical practices in its social interactions as well as in its governance.?

In a time when the Multinational Corporations and tech giants have become more powerful than the Nation-State and have more wealth than the GDPs of entire countries, It is becoming highly difficult to regulate and force them to comply with guidelines. In a study of the global economies by Global Justice Now- an NGO, among the world’s top 100 hundred bigger economies, 69 are corporates and only 31 countries.? Hence, It becomes farcical to think that States can regulate corporations and make them stick to social, environmental, and governance-related responsible practices.

In this case, it seems pertinent that one should look towards the market itself for dealing with the monstrosity of the market. ESG is a step in that direction.?

‘Environmental’ in ESG refers to the organisations’ focus towards energy use, recyclability, pollution control, and protection of the ecology. ‘Social’ refers to its relationship with its employees, suppliers, customers, stakeholders, and the larger community. Governance refers to its governance structure, its alliance with certain figures/families, its board of directors, the role and nature of the executives, its compliances, and internal controls.?

The potential investor is expected to evaluate the performance of the company on all these parameters and then decide to invest in the company. This responsible investing will influence the boards and management to focus on these issues and improve their ranking to be an investing hotspot.

Evolution of ESG

The term ESG was coined in 2005 in a study titled ‘Who Cares Wins’ by Ivo Knoepfel. The idea of ESG sprang from an initiative of Kofi Annan, the then United Nations General Secretary. In January 2004, he wrote to 50 CEOs of major financial institutions, inviting them to participate in a joint initiative under the auspices of the UN Global compact and the support of the International Financial Corporation and the Swiss Government. This initiative led to the publication of a report entitled “Who Cares Wins” by Ivo Knoepfel. The report made the case that embedding environmental, social and governance factors in capital markets make good business sense and leads to more sustainable markets and better outcomes for societies.?

The idea of responsible investing which started with this was first manifested when the New York Stock Exchange released the "Principles of Responsible Investing" (PRI) in 2006. Next year, the Sustainable Stock Exchange initiative was launched.

These indices and many more amendments and improvements into them has led to the formulation of ESG framework which encompasses all the aspect of responsible business.?

Issues in Implementation

ESG is a sound idea to seek compliance and have effective control of the people on these larger-than-life corporations. It has to be seen how the parameters are agreed upon and how the data is collated on those parameters which will lead to the ESG indices. There are no agreed-upon parameters and data points on which the data will be collected and analyzed. There could be multiple ways organizations will collect and analyze and present ESG data.

Self-disclosure of ESG data by corporations/Organisations also has its issues. Who will verify these self-disclosures? Who will assess if certain aspects have been left and certain issues have been embellished and presented out of proportion?

There is also no clarity on what will be the duration of the ESG disclosure. If the companies are going to disclose their ESG performance yearly or half-yearly or quarterly will also have significance. ESG issues like exploitation of labour, emission of noxious gases, or pollution of water bodies cannot be left for a year to be assessed as much can happen in a year. If quarterly assessments are needed, will these corporations invest their resources quarterly for this exercise?

There are so many grey areas that need to be debated, discussed, and deliberated to come to a final methodology of the ESG disclosure and ESG reporting.