In my previous post, I talked of what ESG is all about, and what it isn’t. But a lot of people still ask, why practice ESG at all?

Here’s a handful of good reasons.

Neglected risks come home to roost: Financial institutions (FIs) have traditionally overlooked many very-real operational risks in their decision-making processes. ESG rounds them all up, and forces FIs to consider them, for their own good.

The consequences of ignoring these risks are not few and far between. In recent years, textile plants in Madhya Pradesh have shut down due to water shortages. Polluting industries on the banks of the Ganges, slapped with regulatory fines, have closed shop. Labour strikes have brought production in auto OEMs to a grinding halt. Corporate governance failures and frauds in presumably reputed companies frequently made headlines, unmade reputations and resulted in significant loss of shareholder interests.

FIs could have seen these coming, or spotted patterns of violations, had they put in place robust environmental and social risk management frameworks. Weighing these risks against the company’s performance could also have led them to take more effective investing and lending decisions, directly impacting their bottomline. In the absence of past controversies, tracking an investee company’s performance of specific parameters vis-à-vis its peers also becomes a good aspect to track.

Some FIs with a short term view tend to brush off sustainability risks as something that matters only in a distant future. But that future is already here.

The recent Bengaluru floods is estimated to have cost companies ~Rs 225 crore, not to mention the significant toll it has taken on employees’ and residents’ well-being and productivity.

If you don’t, the regulators will make sure you do: Globally, regulators are taking a keen interest in ESG. India is not far behind.  Being aware of and complying with ESG regulations are simply what firms and FIs must do, to not get on the wrong side of the law and incur penalties. Keeping abreast with the latest developments on the technology and regulatory fronts is also the smart thing to do, as it better prepares corporates and FIs alike to manage transition risks and headwinds ahead.

It’s good for your business: Gen Z and millennial shoppers are leading the sustainability revolution from the front. And they are not also easily fooled. Building a strategy around the opportunities created from an ESG lens can yield dividends. A survey by Bain & Company shows, at least 60% of consumers in India are willing to pay a premium for sustainability products, while 52% in urban areas expect to increase spending on planet-friendly brands in the next three years. It also notes that 49% of the consumers are health conscious and 43% rank sustainability as one among the top-five key purchasing criteria. Yet, sustainable products comprise only 5% of market share in packaged goods. This presents a huge market opportunity.

It opens up investment avenues: The opportunity comes from thinking out of the box in order to solve some of the significant sustainability problems of the present and the future. It is estimated that India will require $2.5 trillion over 2015 to 2030, or roughly $170 billion per year for climate action, according to the country’s nationally determined contributions. Global analysis and advisory organisation Climate Policy Initiative finds that green finance flows totalled only $17 billion in 2017 and $21 billion in 2018 — a huge investment gap and opportunity. Similarly, a Standard Chartered report notes that India needs $2.64 trillion to meet the UN’s Sustainable Development Goals (SDGs), with investment opportunities for the private sector alone at over $1.12 trillion by 2030. Green and SDG-aligned sectors and companies (beyond renewable energy) with the potential to transition the economy present good potential for scaling up. These could include biofuels and other waste to energy sectors, carbon capture and storage technologies, water and sanitation, green infrastructure such as buildings, financial inclusion products for the un-banked, climate-resilient agriculture and food storage, robust crop insurance, and energy efficiencies in micro, small and medium enterprises (MSME).

The ‘X’ factor: Companies known to authentically practice ESG have demonstrated to have a competitive advantage amid a sea of other contenders. This will also begin to play out for companies in the pre-IPO stage as well as those that are raising capital. Investors are beginning to consider ESG as a leading indicator of a company’s future financial performance, resilience and stability. So having an ESG readiness plan pays, quite literally.

FIs and corporates who are already implementing ESG and can demonstrate positive impact through their investments or operations — be it water reduction, energy efficiency, gender diversity or linking executive pay to sustainability targets — would increasingly tend to be favoured.

It correlates well with financial performance:  This correlation is borne out, especially on the ‘G’ aspect, according to CRISIL’s ESG scoring exercise of 586 companies in 2022. The absolute operating profit of the top 10 companies on the G parameter grew at 23% compound annual growth rate (CAGR) between fiscals 2019 and 2021, whereas that of the bottom 10 logged a negative CAGR of 7%. These companies also outperformed their own sector averages. It also stands to reason that the top 10 G scorers outperformed by 900 basis points (bps), with six out of 10 companies outperforming their respective industry averages. Conversely, the bottom 10 G scorers underperformed by negative 1,200 bps, with seven out of 10 companies trailing their respective industry averages. Similarly, as long term stewards of capital, engaging with companies to improve their ESG performance can not only ensure that the companies continue to operate in the long term but also potentially generate alpha.

For companies too, more resource- and water-efficiency, less packaging, and use of more recycled materials would lower the unit-cost structure and boost financial performance.

It gives you a license to operate: If all your stakeholders are happy – be it your customers, employees, shareholders, communities, supply chain vendors – executing operations are smoother, with fewer disruptions.

It’s time to wrap up this post with some quick takeaways on why not to practice ESG.

Don’t practice ESG simply because…

The market is doing it: Institutions that launch ESG funds with this motivation tend to follow a superficial approach to ESG analysis. They either don’t have the capacity to perform in-depth risk analysis, or are not interested in going the full way. Or both.

This has tended to an overweighting on technology and financial stocks, which then leads to poor financial returns when the markets sways towards energy stocks. In the next blog post, I will discuss the ‘how’ of ESG, and elaborate on potentially efficient ways to going about implementing ESG strategies.

It’s good for your reputation: That may be a consequence of doing ESG right, but cannot be the guiding principle. It’s what leads to greenwashing, or generating glossy sustainability reports with no substance or emphasis on materiality. There are others who think of ESG as a philanthropic exercise and are okay with a trade-off with returns. But both these do not lead to positive outcomes for all stakeholders in the long term.

In short, to practice ESG is to acknowledge that the times are a-changin’. And it would be prudent to be ahead of the curve.

FIs and companies that implement ESG for the right reasons will find themselves picked over the others. The new generation of genuinely sustainability-conscious customers and investors will make that happen.