From shareholders to stakeholders

In part I of a series, the authors discuss evolution of the environmental consciousness of companies

All over the world, business corporations are being made to move beyond immediate financial performance and exhibit their commitment towards addressing environmental, social and governance issues (ESG). The environmental consciousness of companies has evolved over three stages. It has its roots in the momentum created by various international agreements and alliances. The UN Sustainable Development Goals (2006) highlighted the role of business corporations in protecting the environment. The UN Principles of Responsible Investment (UNPRI) and the adoption of the Paris Agreement under the UN Framework Convention on Climate Change (UNFCCC), have made environmental issues a pivotal concern for corporations. This was followed by the report of the Task Force on Climate-related Financial Disclosures (TCFD) formed by the Financial Stability Board.

 
This wave has hit the Indian regulatory framework as well. The new thinking which has emerged is the consensus that the interest of shareholders has to be taken care of for a longer and sustainable period not just from quarter to quarter. The emphasis has also broadened from shareholders to stakeholders — including employees, customers and the community at large. The changes have been brought about often through voluntary guidelines and making them mandatory after a while. The Ministry of Corporate Affairs (MCA) in 2011 formulated the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business which had a Business Responsibility (BR) Reporting format. In 2012, SEBI mandated the inclusion of the BR reports in the annual reports for top 100 listed companies and then extended this requirement for 500 listed companies in 2017. Non-compliance or providing misleading or factually wrong report can invite penal action.

 
The second wave that has emerged is the pressure from institutional investors such as pension funds, insurance companies and mutual funds. The concept of stewardship first brought out in UK has also taken roots. Being under pressure from their own investors there has been a quantum improvement in the focus of these large investors, these funds have sharpened their focus towards environmental issues. Companies are being forced to improve their environment practices, report these and be prepared for peer comparisons. Shareholder are abandoning companies where, in spite of decent financial performance, the track record on environmental issues is poor. As per a report by Arabella Advisors in 2018, investors with $6.2 trillion in assets under management have been committed to divest from fossil fuels, up from $5.2 trillion in the previous report in 2016.

 

According to the Global Sustainable Investment Alliance, at the start of 2016, more than a quarter of money, $22.89 trillion, managed around the world is now invested with ESG factors in mind. There is strong research evidence that ESG investing can deliver better returns since companies with strong sustainability scores demonstrate consistent operational performance and are less susceptible to economic exigencies. For instance, the 35-member MSCI India ESG Leaders Index, providing exposure to companies with high ESG performance relative to their sector peers, has outperformed the 78-member MSCI Index over a long-term period from September 2007 to January 2019. The Morningstar India Sustainability Index has returned 14.8 per cent from 2012 to 2016, compared to 13.7 per cent for the Morningstar India Index.

 
Further, Investors are having intensive dialogue with companies to push them down the path of aligning their business practices with ESG criteria. According to ISS Corporate Solutions, a unit of Institutional Shareholder Services (ISS), a proxy advisory firm, nearly half of all environmental-related proposals were withdrawn in advance of 2019 meetings, compared with 33 per cent two years ago. Another driver of this wave are the socially conscious millennial investors. As per a Morgan Stanley study, millennial investors are nearly twice as likely to invest in companies or funds that target specific social or environmental outcomes.
 
The third and the most recent wave is the realization on the parts of business corporation themselves that it make sense for them to be conscious and take advance action rather than being penalised by authorities or pushed by investors. In August 2019, the Business Roundtable in United States -- comprising 181 CEOs of the world’s largest companies -- adopted a new approach to defining the purpose of a corporation to create value for all stakeholders and not just shareholders. This is the first time corporates have stepped up to steer the discourse on business responsibility towards the environment and society. 2,138 companies from 145 countries, representing $36.6 trillion in revenue are taking climate actions recorded on Non-State Actor Zone for Climate Action (NAZCA) maintained and operated by UNFCCC.

 
The path ahead of Indian corporates is clear -- adopt a sustainability oriented mindset to steer the company towards being conscious of the interests of all stakeholders. With rising levels of natural calamities and the sale of air purifiers shooting up as the residents of Delhi struggle to breathe in the city’s highly polluted environment, the alarm bells are ringing loud and clear. Addressing environmental concerns is going to be a determinative factor in the sustenance of a company. The truth in Greta Thunberg’s words at the United Nations Climate Action Summit in September cannot be ignored any more: “... The world is waking up. And change is coming, whether you like it or not.”

 
Tomorrow: The ‘social’ aspect of ESG
 
Sinha is senior advisor & Sood is associate, Cyril Amarchand Mangaldas