Introduction

Investors, governments and as a result, most companies are increasingly becoming socially conscious of their responsibilities. Across nations, the Environmental, Social and Governance (ESG) related compliances and disclosures, are being welcomed and developed. India is also slowly and gradually developing regulations around ESG.

This article focusses on sustainability reporting as practiced in India in the following sections:

Section I – What is ESG?

Section II – Co-relation of ESG with business

Section III – Tracking the growth of ESG in India

Section IV – Analysing the efficacy of Business Responsibility and Sustainability Report (BRSR)

Section V – Conclusion

I. What is ESG?

The Environmental, Social and Governance factors, popularly known as ESG, are standards set to monitor a company from the perspective of a socially conscious investor.

The ‘E’ environmental factors are used to screen the impact of a company’s operation on the environment, both direct and indirect. The ‘S’ social factors are the relationship of the company with the employees, labours, consumers, suppliers, and other stakeholders. The ‘G’ governance is based on the diversity in the board, leadership, remuneration of the board, engagement of the stakeholders, and independence in matters of financial auditing and reporting.

The consideration of these standards earmarks a subtle shift from the traditional financial-centric and profitability approach of investing, to non-financial factors concerning business.

  II. Co-Relation Of ESG With Business

This concept was conceived in 2005, through a United Nations study titled “Who cares wins”.[1] This report developed guidelines and recommendations on how to better integrate ESG issues in asset management, securities brokerage services and associated research functions.[2]

The surge in its importance is evidenced by the fact that ESG accounts for 25% of the professionally managed assets around the world.[3] There is sufficient evidence of the positive impact of ESG on the profit maximization of companies.[4]

However, a valid concern still is whether the increased expense of disclosure and compliance would ultimately be detrimental to the shareholder’s interest. Placing profit maximization above all other considerations[5] is no more a norm and non-financial considerations are playing a major part in attracting investors.

For instance, companies with higher ESG ratings have been found to yield better risk-adjusted returns.[6] During the 2008 financial crisis, the companies with better CSR policies fared better.[7] Following ESG related compliances safeguard the companies from various kinds of sanctions that may be caused due to violation of certain laws (such as environmental damage, human rights abuse, sexual harassment, etc). The companies that align themselves with ESG norms, create a comparatively clean image in the eyes of investors, thereby positively impacting their reputation.

Specifically in India, the data from the National Stock Exchange (NSE) reflects the comparative advantage that ESG index companies have shown over other companies.[8] Similar results have also been seen in various countries.[9]

III. Tracking the growth of ESG in India

In the last few decades, India has seen a shift in its policies towards the corporates as a combined effect of regulatory compliances, voluntary policies, investor sentiment, judicial decisions and global trends. Companies are now required to make much more disclosures and create an inclusive environment within, as a combined effect of certain hard and soft compliances (comply-or-explain basis).

The Indian legislature has followed a fragmented approach in its attempt to bring the Indian ESG regime in line with its global counterparts. The disclosure of non-financial information is regulated by the Companies Act, 2013 (Companies Act), along with rules and regulations issued by the Securities and Exchange Board of India (SEBI). While almost all requirements under the former bind all the companies registered in India, the latter is restricted to a certain number of companies.

The regulatory era in this field began in 2009 with the guidelines issued by the Ministry of Corporate Affairs (MCA) on Corporate Social Responsibility (CSR).[10] These were refined through the National Voluntary Guidelines on Social, Environment and Economic Responsibilities of Business (NVG).[11]Initially,the objective was to instil a sense of social, environmental and economic responsibilities within businesses. Notably, these were not binding on companies.[12]

In 2012, SEBI by insertion of clause 55[13] in the Equity Listing Agreement, made it mandatory for the top 100 companies by market capital to mandatorily file a Business Responsibility Report (BRR), increasing the threshold to 500 companies in 2015 (w.e.f. April 1, 2016) and finally to 1000 companies in 2019.[14]

Recently, based on the recommendations in the MCA report on Business Responsibility Reporting, BRR has been modified to Business Responsibility and Sustainability Report (BRSR).[15] It has made its way into the regulations by amending the SEBI (Listing Obligations and Disclosure Requirements).[16] The BRSR will take effect from the Financial Year 2022-2023, after which it will be mandatory for the top 1000 listed companies by market capitalisation.[17]

The objective of BRSR is to form a “single comprehensive source of non-financial sustainability information relevant to all business stakeholders – investors, shareholders, regulators, and the public at large”.[18]

Besides the mandatory disclosures imposed by SEBI, there are certain obligations under the Companies Act in line with ESG standards. The Companies Act casts a fiduciary duty upon the directors to act for the benefit of the company and its members, employees, community and protection of the environment.[19]

In 2013, the MCA made it mandatory for companies to carry out projects on CSR, thereby promoting social and economic welfare.[20] The provisions on CSR were introduced to harness business efficiency and innovation for inclusive growth.

This move by the Government made India the first country to make it mandatory for certain categories of companies to carry out CSR activities.[21] This mandate is included in Section 135[22] read with Schedule VII[23] of the Companies Act, 2013, Companies (Corporate Social Responsibility Policy) Rules, 2014[24] and Companies (Corporate Social Responsibility Policy) Amendment Rules, 2021, which outline the categories of companies to which the aforementioned is applicable and also lays down supporting rules & guidelines on the conduct, reporting and prescribed limit of minimum contributions pertaining to CSR activities.[25]

To encourage inclusivity, the Companies Act also stipulates provisions for mandatory inclusion of at least one woman director in the case of prescribed companies.[26] The inclusion of a statement in the board report regarding the Constitution of an internal complaints committee in line with the Prevention of Sexual Harassment at Workplace Act, 2013, is mandatory.[27]

Further, in 2017, SEBI issued an advisory that Integrated Reporting be adopted voluntarily by the top 500 companies preparing BRR Reports from the financial year 2017-18.[28]

IV. Analysing the efficacy of BRSR

This section provides an overview of sustainability reporting through BRSR in India. The focus will be on the need for introduction of BRSR, how it resolves the anomalies within BRR, and identifying certain gaps within the framework.

1. Need for BRSR

The need for replacing BRR with BRSR was explained in the MCA report, which placed reliance on a study of 490 listed companies conducted by the Indian Institute of Corporate Affairs (IICA). The study found that the companies were compliant with BRR, but in the absence of any guidelines, the companies were interpreting the disclosure requirements in different manners – although disclosures were being made, they were not qualitative.[29]

In the BRSR format, considerable emphasis is laid on metrics that can be quantified, thus enabling comparison. Certain disclosures related to customers and community have been made granular.[30] The nature of disclosures is specified through two indicators – essential (mandatory) and leadership (voluntary). The entire BRSR format has three criteria – general disclosures, management and process disclosures; and principle-wise disclosure.[31]

An overview of key issues within BRR and how BRSR resolves the same is demonstrated in the table below:

Source: Report of the Committee on Business Responsibility Reporting[32]

It is evident from the table that the missing aspects in BRR have been taken into account by BRSR. This, however, does not mean that BRSR is perfect!

2. What is included within ESG?

There is a lack of consensus amongst nations on the contours of investments related to ESG and the exact impact of social and environmental factors on investing.[33]  As a result, several factors define ESG. In the EU and China, concerns have surfaced over too many funds being sold as ESG funds. The regulators in the EU have proposed rules where a fund has to specify why is it defined as an ESG fund. In India, currently, there are no guidelines that cover this aspect.

3. Inherent fallacy in the rationale for categorization

These standards have made Indian companies more considerate towards non-financial factors. Positive trends in ESG reporting have been visible in India through studies.[34] However, the authors believe that the rationale used for the categorization of companies for mandatory filings, might not help India overcome barriers in becoming an ESG compliant nation and ultimately meet the Sustainable Development Goals (SDG).

A. Market capitalization centric

The rationale for choosing market capitalization for following BRSR is to ensure preparedness on part of other businesses. The listed companies with larger capital or those based on exports are accustomed to making such disclosures. However, the other companies are less ready – therefore, the disclosure on their part is on a voluntary basis. The ultimate goal is to gradually extend the disclosure requirements to all businesses and achieve SDGs.[35]

However, the means taken to the end might make the entire process futile due to the irreparable damage that might be caused by the time all the companies are required to make sustainability-related disclosures. An alleviation in environmental damage and enhanced governance structure is not directly associated with the market capital of a company. For instance, a company with greater market capital might cause much less environmental damage vis-à-vis a company with lesser market capital. These factors are often dependent upon the industry in which the company operates.

Therefore, classification based on the dual factors of capitalisation and industry might be a better approach. The ‘one size fits all’ nature of the disclosures needs to be more industry specific. If a company with lesser market capital cannot take the added cost of disclosures, then instead of all the disclosures, only the ones pertaining to its industry that are notorious should be asked for and some cooling off period may be provided for making other disclosures.

It has been established through several studies that a proportionate relationship exists between ESG-related disclosures and the profitability of a company.[36] For instance, top Indian companies such as Tech Mahindra, Infosys and Wipro are a part of the Dow Jones Sustainability Index (DJSI), which assesses the ESG performance of companies globally.[37] It has been observed that the companies that are part of DJSI and are ESG compliant, have fared well in India.[38] This is due to the fact that investors now seek companies which are seen to be more socially responsible.[39]

One might also argue that the BRSR-lite, which also has both categories of questions but in lesser numbers and has been introduced voluntarily for the remaining companies, would propel them to follow ESG-related compliances. To scrutinise the genuineness of this proposition, it is pertinent to look at the voluntary disclosure regimes in the past.

B. Voluntary disclosures

The term voluntary disclosure can have two meanings. Firstly, disclosures are made by a company voluntarily without any existing regulations. Secondly, disclosures are based on guidelines but are not mandatory. The latter is of concern for the present purpose.

A study conducted on voluntary disclosures made by NIFTY companies showcased that out of a sample size of 42 companies, only 45% made voluntary disclosures related to financial and non-financial factors.[40]

More recently, an ESG analysis of 50 listed companies was published, consisting of the ones that have disclosed such information using either sustainability report or voluntary integrated report.[41] These were amongst the top 100 companies as per market capitalisation – they were obliged to make mandatory disclosure under BRSR. The report highlighted that the response of companies was least positive on disclosures pertaining to principle 7 (public advocacy).[42] For others, the compliance percentage was higher.[43] One of the main reasons for this was that most of these principles were governed by formal legislation, thereby making the compliance rate higher. This signifies the impact of mandate and resulting sanctions. The question pertaining to evaluation by an independent auditor received the lowest overall average, the reason being the same was a voluntary requirement. [44]

The compliance percentage for voluntary disclosures is much less than that for mandatory ones.[45] This is not surprising. However, what is important is that these companies were the top 100 companies based on market capitalisation, yet they resisted making voluntary disclosures to save additional costs wherever possible. Following this trend, companies with significantly lesser market capital might resist making voluntary disclosures and even if some of them do make disclosures, they might not necessarily be the problematic ones/ the ones towards which the disclosure should be directed.

It is crucial to see the reporting standards followed in other jurisdictions for understanding the basis of mandating reporting compliances.

C. Criteria for deciding reporting standards: other jurisdictions

The reporting requirements in jurisdictions vary due to considerations such as legal traditions, domestic interest and differences in governance.

For instance, in the US, heed is paid to the principle-centric approach[46] when it comes to mandatory disclosures, while voluntary disclosures are governed by the market demand.

EU has adopted a regulatory approach for enforcement of materiality considerations.[47]

The Non-Financial Reporting Directive (NFRD), is the most comprehensive legislative framework around the EU for sustainability reporting. It requires public-interest companies with more than 500 employees to make ESG-related disclosures. EU has recently adopted a proposal on Corporate Sustainability Reporting Directive (w.e.f. January 1, 2023), which extends these disclosure requirements to large companies and the ones listed on EU-regulated markets besides the micro-enterprises.[48]

In the US, the Security and Exchange Commission (SEC) obligates public companies to make certain ESG disclosures. [49] The disclosure reporting requirements in the US are much lower compared to other advanced markets.[50]

In UK, listed companies are obliged to report their annual emission of greenhouse gas and diversity.[51] The report on compliance with the Corporate Governance Code, 2012 is to be submitted by premium listed companies. [52]

In Canada, all the public listed companies federally incorporated under the Business Corporation Act have to make a disclosure regarding the diversity in their board. [53] Further, disclosure pertaining to a representation of under-represented groups is needed. [54] There are no mandatory requirements related to environmental or social aspects of ESG. [55]

In China, 2 stock exchanges namely Shanghai and Shenzhen have mandated listed companies to make certain mandatory disclosures related to ESG[56].The Securities Regulatory Commission along with the Ministry of Environmental Protection, will soon mandate that all listed companies make disclosure as to ESG risks vis-à-vis the enterprise value linked to it.[57]

While in some countries like Hong Kong and Singapore, ESG compliances are to be followed on a “comply or explain” basis – the companies are obliged to follow them, and on failure to do so, they have to provide bona fide reasons for not doing the same. [58]

V.  Conclusion

India has been striving to establish itself as a business friendly country to attract foreign investments. Lesser compliances play a formidable role in attracting investors, but this is not the case when it comes to ESG related compliances.

India has been on a continuous task to bring its sustainability reporting requirements in line with the global standards and BRSR is a welcome step.

What is required is re-thinking the criteria for mandatory disclosures as per BRSR.

A combination of industry along with market capitalization may be a better approach to follow. A sector-wise study to decide the threshold of employees might also help delineate the threshold in a better manner. This would be in line with the NFRD criteria of taking a number of employees as a determining factor. Under ordinary circumstances, a company with higher market capitalisation would have more employees as well. At the initial stages, the small companies[59], MSME’s[60] and home-grown businesses should be left out of the mandatory disclosure – for lack of adequate capitalisation and lesser ability to impact the environment and community at large.