Banking Article, Banking Finance 2022, Banking Finance August 2022

Stakeholder Capitalism-New Normal

“Stakeholder Capitalism” is making headlines in economic and corporate world and the World Economic Forum has envisioned it be the future of trade and investment. The concept which has transformed the purpose and goal of business and ensures that business serves society at large, gained momentum after Larry’ Fink’s (CEO Black Rock Investment) letter in 2018 to CEOs to make a positive contribution to society.This concept propagates that usefulness of a business/ company should be measured in terms of well being of all stakeholders.There is a growing social movement to rethink capitalism. The investors too are throwing their weight around the theory of stakeholder capitalism to drive long term value creation and sustainable growth by integrating ESG factors and regulations into their business strategies and assessment models to better manage & assess risks beyond “conventional” business & financial performance so that better capital allocation can be done.

ESG stands for Environmental, Social & Governance practices being followed by an organisation.These three aspects are mandatorily considered when investment decisions are made under ESG investment concept.It is being increasingly realised that investment decisions based on ESG factors, in addition to financials, is advantageous for investors in the long term towards achieving sustainability and value creation.Further “Environmental, Social and Governance(ESG)” factors are attracting serious attention of all stakeholders i.e. governments, regulators, investors, lenders and corporates and this will transform not only investment and its management landscape,but it has potential to bring about attitudinal change in corporates towards business goals and objectives.This also ensures adoption of comprehensive risk management practices on the part of the corporates.

The traditional approach of investing considers only financial parameters and looks at financial risk reward balance. Responsible or sustainable investing (ESG) concept evaluates not only financial parameters but ESG parameters also to improve long term outcome as it considers ESG factors also as economic factors. ESG data is being increasingly used to identify material risks to have a full understanding while assessing the worthiness of a company for investment. ESG investing is based on the concept of sustainable investing i.e. investing in companies who vouch for ESG theme- well being of the stakeholder.

Environmental empathy, Social responsibility and Ethical Governance are three pillars on which the concept of ESG investing rests. Environmental empathy is judged based on the approach used by a corporate towards clean energy,waste disposal, pollution prevention, water conservation and climate change. Gender equality, Labour welfare & rights, women empowerment, donations to social causes reduced inequality and ensuring product quality helps an organisation being socially responsible. A fair and transparent corporate governance which is based on efficient and strong internal control, ethical practices and a strong management culture ensures that the company will fulfil its environmental and social responsibilities.

The growth of ESG investing can be attributed to three factors:

  1. The face of planet is changing. Climate change, natural calamities, environmental imbalance, rising economic and social inequality have far-reaching impact on the world.
  2. The profile of the investors is changing. Millennial investors have inherited huge amount of money and therefore are wealthy. They prefer responsible investment as investment for them is to express their values.
  3. Improved data gathering techniques have made available more granular data on the performance and activities of the companies which can be harvested to assess the ESG commitment of the companies.

Covid19 has made ESG investing more relevant and important both for the businesses and investors with growing realisation that business must be in harmony with the environment and society to achieve increased resilience against disruptions. The “green swan risks’ are potentially more serious than systemic risk as they pose a threat to the existence of not only economy but humanity too.Extreme weather conditions will pose threat to infrastructure and worsen credit, operation, and liquidity risks. The current asset prices are not discounting/reflecting the possible impact of climate risk. The central banks are aware of these macro financial risks and formed “The Network for Greening the Financial System (NGFS)” in 2017 to develop and propagate research on climate related risks which can be used to align their monetary and other policies to green financing. RBI also became a member of the NGFS in April 2021 and in its Financial stability Report (FSR) 2021, climate risk has been identified as a major risk to financial stability.Business Responsibility and Sustainability Reporting (BRSR, May 2021), the new reporting requirement of SEBI which is applicable to top 1000 listed companies clearly indicates the preference of regulators towards ESG.

The growth of the ESG market is based on cumulative research findings that adherence to ESG standards does not damage the profitability of investments rather it brings positive results for both the investors and corporates. A company/organisation with fair and transparent ethical governance engenders government support and attracts least regulatory intervention. Better compliance risk management reduces the probability of undesired events like litigation, fraud, and other high intensity risk events. The possibility of regulatory sanctions, punitive action by government on account of environmental issues and taxation gets reduced as the companies will behave more responsibly and is aware of the impact of their ESG negative actions. Higher employee satisfaction improves productivity and lowers attrition rate.  Sensitivity to climate change, societal issues and governance culture ensures company’s future earnings and growth, and sustainability creates better wealth for the investors. Through several studies,it has been established that ESG practices have resulted into better operational efficiency, better stock performance and reduced cost of capital. ESG companies carry higher valuation due to increased trust level of investors and are preferred due to low volatility and lower betas. The Nifty 100 ESG Index has shown a better performance than the Nifty 100, its parent index.

ESG investing concept is catching fast ESG funds have become popular around the world and growing globally. An estimate by Bloomberg suggests ESG investing to grow @15% and may touch $ 53 trillion by 2025 representing more than one third of the projected $140.5 trillion under AUM. Every day a new ESG fund is being launched. ESG funds in India received an inflow of Rs 3686 crores in 2020-21. ESG investing is being promoted by governments and international organizations through developing various mechanisms, taxonomies to identify investments as conforming to ESG principles, and policies to incentivize ESG-conforming securities.

pt of ESG investing in India is at a nascent stage but growing fast and is more relevant for India where massive new infrastructure investment is taking place amid growing concerns for environmental sustainability. India has around 17% of world’s population but only 2.4% of the world land creating pressure on environment. 11 Indian cities figure in the top 12 polluted cities of the world.  India is in the list of top 10 most vulnerable countries to climate risk released by German watch a Bonn based think-tank. (Global Climate Risk Index 2020). Gender discrimination is still visible, and poverty along with illiteracy is affecting India adversely. Income inequality is a major concern.

However, India has strong potential to attract huge capital investment from all over the world, which can be realised only if our corporates have strong governance framework as overseas investors prefer fair, transparent, and responsible governance. During the last two decades, India has witnessed several corporate frauds which has raised concerns in the minds of overseas investors towards the quality of corporate governance in India. Indian companies have started realising the importance of ESG concept and awareness is increasing in shareholders and rising millennial population of the country who are the potential investors. Indian regulators are also in action to ensure better ESG standards in Indian companies as India as a country is exposed to environmental and social issues. Indian rating agencies have also started evaluating Indian companies by assigning ESG scores. Recently CRISIL Ltd. has published the ESG scores of 225 companies in India.

Though investors and investment professionals are increasingly showing their interest in assessing the impact of ESG on investment and its contents are finding larger place in the investment decision making curriculum, yet the ESG metrics or factors are still evolving.  The relevant ESG parameters are contribution of the company to society and environment, protection of human capital, policies and practices towards workforce. Other inputs considered are resilience, biodiversity, occupational health, and safety standards. United Nations released a set of guidelines known as “Principles of Responsible Investments” in 2006 which propagates incorporation of ESG factors into business policy and procedures.  Several institutions/agencies like Sustainability Accounting Standards Board (SASB), Global Reporting Initiatives (GRI),Task Force on Climate Related Financial Disclosure (TCFD), International Sustainability Standard Board (ISSB) etc. are working to identify the common parameters and their materiality to ESG. The G7 countries have taken a step ahead by supporting the call for making climate related financial risks disclosures compulsory in line with the THFD and ISSB. The effort is being made to make the quality of ESG reporting comparable to that of financial reporting.

The World Economic Forum (WEF),in September 2020, has issued “Stakeholder Capitalism metrics” which stands on four pillars and contains 21 core metrics. The four pillars are

  1. Principle of Governance
  2. Planet
  3. People
  4. Prosperity

Majority of the top 250 companies of the world are reporting their ESG performance as per different standards and reporting frameworks butthese WEF metrics are clear and concise, built on current standards and frameworks, provide consistency and comparability and can be a guiding tool to achieve “Sustainable Development Goals (SDG)” of the UN launched in 2015.They focus on activities of the company and are to be included in mainstream annual reports.

Stakeholder Capitalism, which is based on sustainability,well being of all stakeholders, clean investing, and green investing, is going to be the future and new normal.It does not reject the traditional concept, rather it supplements it with additional considerations while assessing any company/business. Though ESG putsequal emphasison environmental, social, governance and financial issues but the possibility of one overshadowing the other remains a valid concern. Therefore, all four individually and their aggregation both are important. Again,it is not necessary for a company to assign equal priority to all ESG factors as priorities will be decided by the prevailing circumstances and materiality of ESG factors to the company but a transition towards more ESG driven activities to build organisational adaptive capacities and resilience is required.Converging to a common set of metrics for assessment and reporting remains a challenge. A set of common and standardised ESG Key Performance Indicators needs to be identified which can be used across the organisation for a more holistic approach to valuing the success or otherwise of the business.

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