The Covid-19 pandemic has initiated persistent calls for a greener global recovery. Its outcomes have made investors wary of the impacts of physical risks on the performance of an economy. Not only are individuals cautious about the effects of government and corporate actions on societies but they’re also equally worried about the direct consequences of their personal consumptive choices. This concern has pushed global investors to seek opportunities that incorporate ESG (Environmental, Social, and Corporate Governance) metrics into financial markets worldwide.
ESG are a rubric that considers the impact of corporations on sustainability and the lives of people. These parameters largely assign ratings to firms after looking at the effects of their undertakings on the wellbeing of their employees, the environment, and society.
They begin by asking several questions such as the following: What impact does a company have on the environment? Does it pollute rivers, land or air? Does it do enough to curb the pollution and care for the communities impacted? Does it pay fair wages to employees who clean up the pollution, as well as employees in general? ESG metrics investigate answers to such questions and generate long-term market outlooks for firms based on the gathered data. Therefore, from our example, companies that fail to clean up their pollution or underpay their staff get poorer ESG scores, while those that pay well and care for the environment get higher scores. In terms of market performance, lower scores indicate a greater likelihood of poorer longer-term financial returns – a correlation backed by statistical studies — while higher scores indicate greater chances of promising longer-term financial yield.
In today’s world, ESGs are booming. According to Bloomberg, these assets are on course to exceed $53 trillion (Rs 3,900 trillion) of the total $140.5 trillion (Rs 10,388 trillion) worth of global assets under management by 2025. Staggering numbers have already been recorded ever since the outbreak erupted last year in January. Assets in sustainable funds, worldwide, hit a record high of roughly $1.7 trillion (Rs 126 trillion) by the end of December 2020, almost 29% up from the previous quarter. Global inflows into ESG funds in the fourth quarter of 2020 were up by 88% in comparison to the previous quarter. In India, 7 of the 10 ESG funds were launched after lockdowns were opened in the second half of 2020 and nearly Rs 3748.96 crore (Rs 37.48 billion/ $505 million) or worth of net inflow was registered in the fourth financial quarter. In fact, as of April 30th, 2021, ESG funds in India manage assets worth Rs 10,377 crore (Rs 103.7 billion/ $1.39 billion).
While ESGs in India are still largely juvenile in comparison to other global markets, they have already started outperforming traditional stock indices. According to the NSE Indexogram on April 30th, while one-year total returns for companies on the Nifty100 stood at 49.23%, they were registered at 54.08% for the Nifty100 ESG Index. The same was the case for a longer time frame. Five-year total returns stood at 14.64% for Nifty100. But for its ESG counterpart, it registered a minuscule, although significantly greater 16.3%. Clearly, the market seems to have picked up the track to ensure longer-term sustainability. The journey, however, is far from complete.
ESGs largely lack a common definition. Most ESG metrics do not agree on where to draw a line on what can be called sustainable and what cannot. This is a global issue that threatens the very fabric that gives them the credibility investors seek. In the US, for example, there is no mandate from the SEC yet on how to define ESG. And while Europe recently came with a preliminary rubric on defining ESG, India’s SEBI too still has to develop a criterion.
The problem in places like India, often also includes a lack of awareness amongst stockbrokers and fund managers. Not only are investors unaware of where to park their money, most stockbrokers and managers too are oblivious of the existing ESG indices and their future market scope. Henceforth, while most market experts are well aware of the concepts like net profits, EBITDA, or inflation, they are only beginning to learn about the impact of environmental and social performance on companies and vice versa. Under these circumstances, the biggest current driver of ESG funds in India isn’t really the domestic marketplace. Rather, such funds are mostly driven by foreign institutional investors who mandate investing in compliance with ESG parameters. India needs reforms and these need to come from the framework that structures its financial market.
First, the upcoming FY2022 voluntarily ESG disclosures declared by India’s SEBI need to be executed efficiently with complimentary guidelines that clearly define the ESG criteria. This hypothetical practice rather also has to be incorporated into the predeclared FY2023 compulsory ESG disclosures. Second, formal and more structured events educating fund managers about ESG compliance need to be carried out. Third, greater reporting requirements need to be mandated for firms to become transparent over time. And fourth, more concerted efforts need to be made to make ESG an integral part of looking at the fundamentals of a company. Only when these factors are collectively applied will India achieve the goal of maximising the opportunity for a greener recovery post Covid-19.
Covid-19 has taught us all an important lesson on sustainability. It is only with a greener mindset can we better mitigate longer-term risks, such as climate change, that threaten the very existence of humanity. Therefore, it is of utmost importance that our market systems become compliant with the forerunning principles of sustainability. The future might, otherwise, be bleak.
Shreyansh Singh Budhia is a researcher with Infinite Sum Modelling LLC, Seattle WA, USA & Dr Badri Narayanan Gopalakrishnan is the founder and director with Infinite Sum Modelling LLC, Seattle WA, USA.