THE POLICY LAB-28
AUGUST 08 , 2023

By J B Mohapatra

SEBI's circular dated 20-7-23 on the subject "New Category of Mutual Fund Schemes for Environmental, Social and Governance ("ESG") Investing and related disclosures by Mutual Funds" attempts to satisfy the long-felt demand for allowing greater degree of flexibility to Asset Management Companies (AMC) and better access to implement more ESG schemes under different strategies than what are being allowed at present, and accelerate the current pace of green financing. So we have now 6 new categories of ESG schemes envisaged around 6 specific strategy that a fund house may choose to adopt: (a) on the basis of exclusion as regards adverse impact, controversy, faith or on third party standard or with reference to any law or regulation (b) on the basis of integration (c) on the basis of best-in-class and positive screening (d) impact investing (e) on the basis of sustainable objectives (f) transition or transition related investment.

While the circular expands the number of thematic funds that a fund house can launch and operate under the ESG bracket to 6 and thereby enable funding of multiple strategy-specific ESG initiatives, the attendant conditions in the circular such as (a) regulatory scrutiny on mis-selling and greenwashing (b) minimum level of investment of fund corpus in investments which meet the criteria of the specific ESG strategy (c) disclosure of specific strategy of the ESG scheme (d) a monthly portfolio disclosure obligation and AMCs with ESG schemes obliged to cast their votes in respect of all resolutions of all investee companies ((e) mandatory fund manager's commentary in the monthly portfolio disclosure (f) an independent reasonable assurance on an annual basis on the composition of the portfolio under the ESG schemes and their adherence to the themes and strategy, have carefully woven regulatory structure around the newly announced ESG scheme at deeper and granular level of their operation.

One condition though consistently followed by SEBI in order to class investments under the ESG basket, also reiterated in the July 2023 circular is the threshold level of admittance of an investee company under the Business Responsibility and Sustainability Reporting (BRSR) disclosures. So, for the ESG category, SEBI would allow investment by AMCs and fund houses in those companies which have comprehensive BRSR disclosures. An ESG scheme thus shall invest at least 65% of its AUM in companies which are reporting on comprehensive BRSR and are also providing assurances on BRSR core disclosures. Balance AUM of the scheme can be invested in companies having BRSR disclosures.

BRSR as a compliance condition for ESG investment in India, developed on the July 2011 Ministry of Corporate Affair's "National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business" and the March 2019's "National Guidelines on Responsible Business Conduct" was meant to convey the intent and scope of the reporting requirement: principally to provide transparency how an organisation contributes to sustainable development, its impact on economy, environment and people, and its strategy to manage and mitigate those impacts. SEBI notification of May 2021 with reference to Regulation 34(2)(f) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 further mandated the top 1000 listed companies based on market capitalisation to submit in prescribed formats their policy and practice with regard to ESG targets and initiatives. The SEBI format configured on 9 principles ( principle 1: integrity and in a manner that is ethical, transparent and accountable; principle 2: provide goods and service in a manner that is sustainable and safe; principle 3: respect and promote well being of all employees including those in value chains; principle 4: respect the interests and be responsive to all stakeholders; principle 5: respect and promote human rights; principle 6: respect and make efforts to protect and restore the environment; principle 7: when engaging in influencing public and regulatory policy, should do so in a manner that is responsible and transparent; principle 8: promote inclusive growth and equitable development; principle 9: engage with and provide value to consumers in a responsible manner ) were meant to enable comparability across companies, sectors and time, help investors to make better investment decisions, and help companies to engage more meaningfully with their stakeholders. Eventually, the BRSR filing could help build an index for ESG investments in India.

Whether or not the BRSR filings, the foundation for ESG investments, are robust enough for investors to make informed decisions, is crucial in answering to the corelation between ESG and BRSR. Below are the 3 significant inadequacies:

One, there is no approved domestic standard for reporting on ESG compliance. Companies that prepare and disclose their sustainability reports based on internationally accepted standards under Global Reporting Initiatives (GRI), Sustainability Accounting Standards Board (SASB) or Task Force on Climate Related Financial Disclosure(TCFD) are required only to cross reference their disclosures in their reports under BRSR.

Two, the present BRSR reporting encompasses all classes of companies in one-size-fits-all format making no distinction among companies who have varied degree of sector-specific, region-specific, jurisdiction-specific vulnerabilities under any ESG framework. It makes no demand for sector- specific data or their disclosure. For example, potential investors in companies engaged in consumer markets would have a larger demand for data on company's policies on plastics, packaging, product stewardship and sustainable marketing. Investors in companies engaged in infrastructure, logistics and real estate would have demand for more granular data on company's labour practice, or policies on procurement of building material, or policies on land oustees and policies on their rehabilitation. So also the need for sector-specific data commensurate to the nature of the industry: for companies engaged in energy, natural resources and chemicals/ technology, media and telecom/ pharma and healthcare/ financial services/ industrial markets and automobiles, each sector having its unique datasets corresponding to the challenges to their ESG initiatives. Moreover, current BRSR format is scale-agnostic, and makes no distinction among the small, medium, large and very large or even segregates the companies in critical infrastructure sectors or companies who are lifelines to our economic survival. A potential investor in a company engaged in oil and gas, for example, would be more interested in data on specific vulnerabilities associated with company's activities of exploration, extraction, production, transportation or in supply of equipment and platform or drilling or downstream activities of refining or in ascertaining implications of hydraulic fracking etc, than the salary gap between KMP and the workmen. A potential investor to a company engaged in coal sector would much rather prefer data on mine closure, its impact on local communities or future viability of operations than any other data. Similar would be the case of an investor in a company engaged in agriculture, or aquaculture or fisheries, who would value data on company's policy on food security or data on animal health or soil health or use of pesticides over any other company data.

Three, responsible tax behaviour and a focus on tax transparency, including company's approaches to compliance, business substance, risk assessment, related party transaction, industry benchmark including data on effective tax rate, stakeholder and regulatory engagement, management concerns related to tax and country by country reporting, wherefrom an investor would be expected to form a view on company's adherence or divergence from its proclaimed ESG theme and strategy do not figure in the present BRSR compliance requirements.

Until such time a domestic standard for ESG reporting is made available and an index is crafted around data validated through those standards, BRSR is the company-provided data in SEBI-approved format for investors to garner quality information when attempting to make their investment decisions on ESG products. Sustainable and responsible investment employing ESG factors in analysing and in selection of investments depends more on the quality and granularity of data demanded of companies in specific sectors of their operation in accordance with their sector-specific specialities and much less on the usual information on greenhouse gases or waste recycling or treatment of employees in disability conditions. A far too general BRSR without bringing in sector-specific specialities or even attempting to segregate per scale or by nature the entities being reported upon may not be meaningfully answering to the needs or even the appropriate manner of green financing. It should not happen in the manner that food delivery companies or companies engaged in matrimonial match making getting classed under the theme of information/ digital technology for thematic classification, that the BRSR data are employed to label a carbon dioxide spewing energy generating company under the ESG compliant category for investment.