Why Sebi’s ESG regulations are unnerving India inc

ITC Ltd, another conglomerate, has a bigger challenge. Its interests range from cigarettes to hotels, and it is wondering how to source similar information from its agri-business suppliers (millions of small farmers) and customers (the thousands of well-heeled individuals in its hotels business).

L&T and ITC have to disclose this information about their value chain annually from 2023-24 to comply with a new standard called Business Responsibility and Sustainability Reporting–Core (BRSR Core), mandated by markets regulator Securities and Exchange Board of India (Sebi). Welcome to the new world of environmental, social and governance (ESG) regulations in India.

Five years ago, India’s ESG regulations, which are essentially a framework to evaluate the sustainability and ethical impact of a company or investment, were minimal or voluntary. Today, they are comprehensive and mandatory, and considered to be at par with global sustainability and reporting standards.

The pace of regulation has left India Inc gasping for breath as it scrambles to meet the norms. Conglomerates such as L&T and ITC were early adopters. Even six years back, ITC wanted its hotels to be “the least harmful". In 2017, the electrical energy consumed at the newly built Grand Chola, ITC’s luxury hotel in Chennai, was being compensated by its own windmills in Coimbatore. But even the early adopters now appear overwhelmed.

A survey undertaken by Deloitte India to gauge the preparedness of organizations in meeting ESG requirements is telling. Only 27% of the businesses surveyed were well-prepared to meet the norms. Worse, only 15% of their suppliers were ESG ready. And less than half of the companies—49% to be precise—were well-aware of ESG reporting needs in India. The survey was released in May, when India’s top 1,000 listed companies by market capitalization were to file their BRSR reports, detailing their ESG work.

Sebi, nevertheless, pressed ahead with more regulations.

Most companies in India do not have a coherent ESG policy yet. They lack proper systems and processes to capture data and report it. The resource shortage, especially in terms of people with ESG related skills, is severe. Not having invested in technology is making things worse for many companies.

A cross-section of large, medium and small companies that Mint spoke to say they are now pressing the accelerator to meet the norms as per “the letter of the law" and not “the spirit". After all, their shares will be delisted if they do not comply, as BRSR disclosures are a part of their listing agreement with stock exchanges. The very purpose of the regulation, to make Indian companies more sustainable environmentally, and in terms of social and governance practices, will be lost if it is rushed through at this pace, they warn.

But first, let’s look at the evolution of these norms, globally and in India.

A brief history

Celebrated economist Milton Friedman had famously declared that a company has no social responsibility to the public or society and its only responsibility was to its shareholders. This ‘shareholder theory’ was keenly followed in the 1980s and 1990s and led to the creation of concepts such as shareholder value and employee stock options. But by the late 1990s, the developed world had begun to move away from it and embrace the ‘stakeholder theory’. The shareholder theory was panned as being wrong on financial, economic, legal, social and moral grounds. In 1997, the Global Reporting Initiative (GRI), a sustainability reporting framework, was launched in the US.

The Indian government’s first step towards regulating this space came in 2011. The ministry of company affairs (MCA) came out with National Voluntary Guidelines (NVG), which encouraged companies to adopt best practices in the areas of human rights, labour standards, environmental sustainability and corporate governance. In 2012, Sebi came out with a Business Responsibility Report (BRR) based on NVG and made it mandatory for the top 100 companies from 2012-13 onwards. In 2015-16, it was extended to the top 500 companies and by 2019-20, to the top 1,000.

In 2019, the MCA introduced the National Guidelines on Responsible Business Conduct (NGRBC) and came out with a BRSR framework based on NGRBC. It was made mandatory by Sebi from 2022-23. In July this year, Sebi introduced the BRSR Core, involving key performance indicators across nine ESG metrics. It has made BRSR Core disclosures mandatory for the top 1,000 listed companies from 2023-24. The regulator did not stop there; it also gave a ‘glide path for reasonable assurance’—a detailed third-party validation of the disclosures made, akin to a statutory audit of accounts. The top 150 companies will need to provide that reasonable assurance from 2023-24 and the top 1,000 by 2026-27.

The sting was in the tail of the circular. The regulator called for ESG disclosures of the value chain, covering both upstream (supply chain) and downstream (customers) partners, comprising 75% of their purchases and sales, respectively. The top 250 listed companies will have to disclose value-chain reporting from 2024-25 and they will have to provide limited assurance—a less stringent form of third-party validation—for value chain reporting from 2025-26 onwards.

Steroids needed

Why are the government and Sebi in such a hurry? It’s because India has to catch up with the rest of the world, having started late in ESG reporting and regulation. For India to sustain its rapid economic growth, these norms are crucial.

Take the case of foreign capital, which has become critical to fund India’s growth. In 2023, the net foreign portfolio inflow—equity, debt and hybrid funds—stood at $16 billion (as of October-end). But investors are increasingly looking at investment through the prism of sustainability, and to attract more capital, Indian companies need to have a clear ESG focus, and disclose their work in line with global standards.

“BRSR-based ESG disclosures offer credibility to investors vis-à-vis mere voluntary disclosure," says Shikhar Jain, executive director, CII-ITC Centre of Excellence for Sustainable Development, an institution that helps businesses become sustainable.

In other words, it eliminates the scope for greenwashing or providing false information about a business being sustainable.

The same goes for debt. Global green bonds are low-cost funds that can help India Inc fund their transition to a low-carbon operation. But to access them, companies need to convince lenders that they have a clear sustainability focus.

Further, India is part of the global supply chain. Companies abroad need to factor in the sustainability efforts of their suppliers in their ESG reporting. Some countries have a faster path to sustainability than India.

“The European Union (EU) has to achieve net zero by 2050 and towards that goal, they need to cut carbon emissions by 55% from 1990 levels by 2030. Indian companies in the global value chain of EU-based companies have to move fast and have emissions reduction targets that fulfil the ESG commitments by European entities," says Jain.

Thus, Indian exporters need to accelerate on the net zero pathway and Sebi’s regulations are aimed at pushing them to do so.

Also, the EU has rolled out a Carbon Border Adjustment Mechanism (CBAM) from 1 October this year in a bid to achieve a 55% reduction in emissions by 2030. This involves reporting direct and indirect emissions embedded in imported goods. If Indian exporters do not have processes in place, they cannot report this data and may end up losing customers. Also, a strong and credible ESG play by companies will help them maximize the ‘China+1’ (a strategy adopted by countries, particularly in the West, to diversify supply and reduce their dependence on China) opportunity.

Most importantly, by embracing these regulations, Indian companies will future-proof their operations. Increased focus on sustainability will make companies efficient and less dependent on scarce natural resources.

“While these regulations have presented certain challenges for companies, viewing them not merely as a regulatory exercise but as an opportunity can enable organizations to better prepare for the future," says Shailesh Tyagi, Climate Change & Sustainability leader at Deloitte South Asia.

Adds S.J.R. Kutty, chief sustainability officer, Tata Motors: “There are complexities and challenges and huge opportunities to find world-first solutions."

Challenges galore

Kutty and other experts point out that BRR disclosures have been around for almost a decade and companies that have proactively followed them would not face too many challenges now as BRSR is just an improvement of BRR. But not all agree.

Complying with ESG regulations and understanding their legal implications is a complex affair, particularly for those operating in multiple jurisdictions, Deloitte noted in its ESG survey report.

Even companies with a track record of voluntary disclosures face several challenges. “There are definition issues and lack of clarity makes getting the right data difficult," says Pradeep Panigrahi, head of corporate sustainability, L&T.

While BRSR is being positioned as an Indian ESG framework, it does not contain all the key performance indicators that GRI or other global frameworks have. For a company looking to raise funds from abroad, the reports are not comparable. They are therefore forced to prepare multiple reports, which is time consuming.

Indeed, companies have flagged a lack of standardization in ESG reporting as multiple global frameworks exist. This makes comparison between companies difficult, much to the frustration of investors, who are already confused with the multiplicity of rating agencies and different ratings they offer for the same company. This is because each rating agency evaluates a company on different parameters, ranging from climate resilience and water footprint to social issues and governance.

Value-chain reporting, mentioned earlier, is another big wrinkle. “While we have adopted BRSR reporting seamlessly, there are challenges that continue to emerge in upstream and downstream value chain partners. For a business-to-consumer company, it is indeed difficult to measure and report the environmental footprint like carbon and water for its retail customers downstream and for individual farmers upstream," says Madhulika Sharma, vice- president and chief sustainability officer, ITC.

Getting data from suppliers is not easy either. L&T tried to work around this challenge by sending a sustainable supply chain assessment questionnaire to its top 25 suppliers last year and plans to reach the top 160 this year—they account for 60% of its purchases.

Companies also point to a lack of resources. “There is a severe shortage of talent. Is the Indian education system ready to produce talent at the speed and scale required? Very few institutes offer an MBA in sustainability," says L&T’s Panigrahi.

There is also a shortage of assurance professionals—consultants who provide reasonable and limited assurance, validating BRSR disclosures.

Inevitability factor

While these challenges are real, multiple factors will force the companies to stop whining and embrace the regulations. According to the United Nations, there have been 7,300 major climate related events in the last two decades. It estimates that the cost of not tackling climate change will cause a global economic loss of $44 trillion over the next 25 years. “The challenge of climate change is real, and it is time for all of us to come together and make a difference," says Tata Motors’ Kutty.

The other inevitability factor is that these regulations have become a business imperative, says CII’s Jain. If Indian businesses want to tap the global market, they have to integrate ESG processes into their core business strategy, embrace technology and future-proof their organization.

The otherwise gloomy Deloitte ESG preparedness survey had some reassuring data points, too. Almost 90% of the companies said that ESG reporting will improve their brand reputation and 75% said that investors rate them on their ESG performance. Given this, the rapidly evolving ESG regulations may well prove to be a short-term pain in India Inc’s quest for long-term gain.