The Growing Importance of ESG Investing; its Due-Diligence, Risks and Rewards

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The increasing demand for ESG (Environment, Social and Governance) investing is pushing corporates to become more responsible socially. Organizations are becoming more aware of the challenges and the negative impact of climate change and biodiversity losses that now stare at the world. With this view, organizations are now focusing on considering non-financial factors in the decision-making process.

In India, SEBI has issued directives to the top 1000 organizations to prepare a Business Responsibility and Sustainability Report (BRSR) for the Financial Year 2022-2023. The report will disclose all ESG-related risks, opportunities and any financial implications because of non-conformance with ESG standards. This is basically done to ensure that companies address important issues related to environmental protection, provide employee benefits and follow corporate governance.

With many challenges and uncertainties surrounding the world today, ESG investing looks ahead as a sure hope for protecting the interest of the people and our planet.

ESG investing

The Three factors:

The “E Factor” (Environment)- This factor considers environmental risks related to operating in the environmental eco-system and use of land, water and air. It includes carbon footprints, greenhouse emissions, renewable resource management and waste management, etc.

The “S Factor” (Social)- This factor considers the human resource management by organizations and the risks involved are workplace bias, employee harassment, sexual harassment, employee exploitation, salary and payment-related issues, etc. The social factor also considers any issues and the well-being of the society in which the organization operates.

The “G Factor” (Governance)- This factor is related to the corporate governance framework of the organization and includes issues like data security breaches, corruption, insider trading, bribery, management practices, etc.

ESG Due Diligence:

ESG due diligence is mostly done in the following cases:

  • Mergers and Acquisition:

Focusing on ESG has helped many organizations to raise funds more than their competitors. Investors, both individual and institutional, pay close attention to ESG factors that are contributing to higher bottom lines. ESG due diligence during mergers & acquisitions helps to identify the environmental impact, social management and human resource management based on the organization’s policies and procedures. The ESG disclosures help in carefully reviewing and valuing the organization accurately. 

Conducting this due diligence in the right manner will help investors understand any problems or issues with ESG policies in order to mitigate any future risks.

  • ESG Audits:

The Indian Companies Act, of 2013 has mandated CSR for all organizations earning profits. The SEBI has now mandated the top 1000 companies to prepare the BRSR report annually. In order to comply with ESG parameters and sustainability objectives, organizations would be required to perform ESG audits.

ESG Audits

The ESG audits would help organizations to:

  • Identify ESG risks and provide approaches to mitigate them.   
  • Identify sustainable goals and track performance 
  • Focus on organizational policies, processes, management and board structure
  • Energy and resource usage, all types of emissions and their impact on the environment
  • Waste management
  • Gender diversity and social diversity prevailing in the organization
  • Occupational health and safety measures in place 
  • Wages, salary, training and other benefits and allowances
  • CSR and social impact
  • Consumer complaints and their redressal procedures
  • Anti-corruption policies, etc.

ESG Risks:

Identifying ESG risks is a complicated task and measuring the extent of risk makes this task a daunting challenge. Though difficult, if this step is done accurately, it would generate returns beyond measure for the organization in the long run. Some ESG risks to look out for are:

  • Overlooking the prescribed pollution/emission standards
  • Ignoring operations/processes that could lead to serious environmental damage 
  • Unhealthy working environment with gender bias
  • Unsafe working conditions
  • No proper anti-corruption rules and policies are in place
  • Not taking corrective action/ proper redressal to complaints of residents around the organizational premises

ESG Rewards:

Organizations that are successful in identifying ESG risks are bound to take corrective steps to mitigate them. A carefully managed ESG framework only reaps benefits for the organization concerned. An organization that carefully invests in ESG framework reaps both short-term and long-term rewards, including:

  • Cost cutting and cost reduction
  • Strong corporate governance
  • Better goodwill, brand image and reputation in the market and industry
  • Reduce/ eliminate any environmental damage
  • Motivated and dedicated workforce
  • Better relations with consumers
  • Creating value for the company and investors

ESG Complications:

Most of the ESG requirements are not enforced strictly on the organizations and they can voluntarily adopt a good ESG framework for society at large. This being said, implementing ESG involves updating current working techniques, and the need for better systems and policies in place. 

All these changes are both challenging and expensive. Since all organizations follow different working approaches, it is difficult to adapt to changes which may lead to lower profitability in the short run. Organizations need to ensure that they collect the right information from all their sources. The management and board need to take corrective steps for not only protect the organization and its stakeholders but also the environment.

Summing up:

The ESG laws in India apply to entities conducting business and engaging in labour-related activities. Currently, many large organizations like ITC, WIPRO, Procter & Gamble, Tech Mahindra, Infosys, etc. are adapting to this sustainable approach, however, it is important for small organizations and start-ups to implement this at an early stage for better rewards.

Financial service providers like Diligen, understand and manage all ESG risks, opportunities and implications. Diligen helps its clients by providing an in-depth ESG analysis by conducting site visits and field-based evaluations. Using benchmarking techniques, Diligen helps its clients to understand the severity of ESG factors by comparing them to various regulated standards. They provide clients with complete solutions that include identifying, assessing, mitigating, monitoring, supporting and training while implementing the ESG framework. 

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