Transparency: a business imperative in a world of ESG-led investing

ESG — environmental, social, and governance — is a hot topic in boardrooms today and is impacting business decisions. There is a verifiable surge in investor and stakeholder interest (including policy makers and NGOs) in companies that take ESG seriously. Investors are also increasingly considering business' ESG performance in their financial decision-making. While investors have made their demands for 'investment grade' information clear, it is difficult for businesses to determine what, how and how much to report.

Against this backdrop and to understand how ESG can help businesses improve long-term value, EY on 8 Dec 2021, brought together global business leaders in a virtual roundtable. Moderated by Chaitanya Kalia, Partner and Leader, Climate Change and Sustainability Services (CCaSS), Mukund Govind Rajan, Chairman, ECube Investment Advisors; R Mukundan, CEO, Tata Chemicals; Reto Isenegger, EMEIA Sustainability Markets Leader & Sustainability Strategy and Transactions Leader, EY; and Rajnish Gupta, Associate Partner, Tax and Economic Policy Group, EY participated in the round table.

The panel commenced the discussion with the increasing popularity of ESG investing and how investors prefer companies that achieve ESG goals. Against the backdrop of PM Modi's speech at the COP26 concluded in Nov 2021, the panel discussed the effectiveness and challenges of the carbon pricing strategy in achieving the country's net-zero goals. ESG, especially climate policies should not be seen as a cost or a part of being responsible corporate but as an incentive to innovate. The idea of ESG being something noble to do may be obsolete. The question is who moves in first with innovation.

Deliberating on the issue of data transparency and ESG reporting, the panelists insisted on the need for uniform global reporting metrics and how globally accepted ESG standards will improve the quality of disclosures and make life easier for companies, investors and policymakers alike. 

Setting the context in which investors evaluate companies and the impact of ESG on decision-making, the panel asserted that it is essential to determine whether a company's top management understands the gravity of the issues around them. The concept of materiality is critical here. While a company is not expected to perform outstandingly across different attributes, those that are particularly material for its industry are critical.

The recent 2021 EY Global Institutional Investor Survey echoed similar sentiments. According to the survey, 74% of investors worldwide are more likely to divest from companies with poor ESG track records.

Explaining the dramatic incline of ESG in Europe, Reto Isenegger, EMEIA Sustainability Markets Leader & Sustainability Strategy and Transactions Leader, EY, said that Europe started with the environment piece of ESG, and regulation drove and accelerated the environmental agenda.

"We see three archetypes or strategies in the European markets. The first strategy is transform or be transformed, which means the company changes its business model to leverage green taxes and incentives. The second strategy is transform to win, which focuses on renewable energy and sustainable finance. Most consumer goods companies follow the second strategy. The third strategy is transform to support others in their transformation, which high-tech companies often follow," explained one of the panelists.

By setting clear regulations and making bold investments in sustainability and emission control, Europe undoubtedly leads the charge to a greener future. However, there is a lot of regulatory scaffolding needed for such strategies to work in India.

Carbon pricing: challenges and opportunities for India

Prime Minister Narendra Modi announced, at the recently concluded COP26, that India's emissions intensity would drop by 46%-48% from 2005 levels. "Carbon pricing is the most cost-effective and flexible way to achieve emission reduction," said Rajnish Gupta, Associate Partner, Tax and Economic Policy Group, EY.

"The biggest advantage of the carbon tax is that it is easy to implement because you can put it as part of GST. However, carbon taxes are not politically palatable. Nobody likes taxes, so to be able to get this strategy across the line is very difficult," he added.

As far as emissions trading in India is concerned, the government may first have to set targets for particular industries. This will help add some subjectivity. Next, policymakers may need to create mechanisms to measure emissions, set institutional authority, and freeze the permissible limit for emissions. A clear regulatory framework for carbon pricing in India can help increase businesses' uptake of carbon pricing. However, while improving enforcement across sectors is vital, the real challenge is to explore the potential for linking with the global carbon markets.

Need for global policies and regulations to make decarbonization happen

In the past, businesses might have responded to stakeholders’ demands with well-chosen words and glossy pictures in the annual report. But today, such tactics are neither adequate to manage ESG as a public relations issue nor enough to handle the demands of investors. What investors want is convincing evidence of a sustainable economic model. This requires the disclosure of a set of nonfinancial metrics. The question now is: which ones? And this is where the concept of materiality comes in.

Panelists echoed the sentiment that companies can publish as much data they want on which theyare doing well. But if those items are not critical to their core business, itis elusive.

Disclosure is not transparency

Discussing an investors' perspective and deliberating on the issue of transparency, one of the panelists shared that almost 75% of the disclosures looked at by the Sustainability Accounting Standards Board (SASB) are not material. Also, 90% of the adverse events do not get disclosed. This speaks a lot about the lack of transparency in ESG disclosures.

The reality is that the demand for transparency over ESG activities is set to increase. Businesses that do not share relevant information or publish inaccurate data will miss out on access to capital. Those able to hit the right notes with investors and stakeholders will gain an edge. 

Looking at the ESG risks and opportunities from investors' perspectives, the panel agreed that there would always be concerns around the trade-off between risk and reward. Investors need to consider the time frame in which they want to see the delta in their performance and whether their competition is doing it simultaneously. 

So, how can investors navigate these challenges?

Answering this question, the panelists reiterated the importance of transparency. The best way for investors is to watch out for gaps in ESG reporting, the authority of the top management to deal with issues, and their intent to deliver on promises. Investors should do a thorough background check and invest only if they get comfort.