From impact investors to the mainstream
Most investors decide on a business's ability to generate profit. Over recent years the societal discussion about companies has also turned to sustainable development and corporate social responsibility, which gave traction to an investment theme built on Environment, Social and Corporate governance criteria: ESG. At first a handful of impact investors used the framework; it spread as it proved to carry commercial value as well.
Three criteria
ESG investors use the criteria to shortlist potential investments. Passing the filter does not make a stock an automatic investment; the investor then performs all the other regular analysis to decide whether it is suitable.
The financial case
The framework looks more ethical than financial, but its proponents cite financial advantages for companies that follow it.
- 1Companies focused on the environment face minimal disruption from regulatory intervention or environmental activism.
- 2Companies working for social causes generate positive recall in society, which makes it easier to recruit employees and attract customers.
- 3Strong corporate governance reduces risk perception, which reduces the organisation's cost of capital.
Equity analysts can include a discussion of ESG parameters in their work to guide investors who care about these factors.
BRSR
The Securities and Exchange Board of India has proposed strengthening regulation of environmental, social and governance disclosures by listed entities to improve their credibility, and has named the top 1,000 listed companies to make ESG disclosures under the Business Responsibility and Sustainability Report (BRSR) parameters from FY2023. That brings the transparency and data points ESG analysis and investing need. In FY22 more than 175 companies reported voluntarily on the BRSR framework.
The top 1,000 listed companies appear twice in this chapter: SEBI mandates separation of chairman and CEO for them (governance topic) and BRSR disclosures for them (this topic). Do not confuse the 175 voluntary FY22 reporters with the mandated group.
Two companies with identical earnings differ in governance: one has an independent-majority board, rotated auditors and pre-approved related party transactions; the other has none of these. Lenders and investors price the second as riskier and demand more, which is the third financial advantage in reverse.
- Most investors judge profit-generating ability, but societal attention to sustainable development and corporate social responsibility gave traction to investing on Environment, Social and Corporate governance criteria, first among a handful of impact investors and then more widely because the framework has commercial value.
- Criteria: environmental impact (low carbon emission and low pollution rank better), social contribution (human rights, gender equality and similar factors), and corporate governance standards. The ESG filter shortlists candidates; a shortlisted stock is not an automatic investment, and all regular analysis follows.
- Financial advantages claimed: environment-focused companies face minimal disruption from regulatory intervention or environmental activism; socially engaged companies earn positive recall that eases recruiting and attracts customers; strong governance lowers risk perception and the cost of capital.
- SEBI has named the top 1,000 listed companies to make ESG disclosures under the Business Responsibility and Sustainability Report (BRSR) from FY2023; in FY22 more than 175 companies reported voluntarily on the framework.