It’s time to rethink the environmental social and governance criteria

Syllabus
GS Paper 3 – Environmental conservation; Environmental pollution and degradation; Environmental Impact Assessment.

Applications where to apply?
When asked about
–  ESG norms
–  Sustainable development
–  Climate change mitigation

Context
The article looks into effectiveness of the ESG approach in addressing global challenges like climate change and social inequality.

Source
The Hindu | Editorial dated  21^st   May 2024

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It’s time to rethink the environmental, social and governance criteria

The acronym ESG, representing Environmental, Social, and Governance criteria, has become a pivotal concept in the realms of business, government, and civil society over the past two decades.  However, the effectiveness and integrity of ESG ratings are increasingly questioned, prompting a re-evaluation of the ESG framework.

ESG framework

ESG was introduced in 2005 by the UN report “Who Cares Wins: Connecting Financial Markets to a Changing World”.

Significance

• Promotes sustainability:
  • Compliance with ESG norms essentially requires every business to be accountable for the responsibility it has towards the environment as well as the people who make up the entire ecosystem either as employees or customers or other stakeholders.
  • ESG encouraged financial institutions, investors, and regulators to promote sustainable practices.
  • Sustainable investments driven by ESG criteria make up over a third of global assets (Global Sustainable Investment Review, 2022).
• Improves business practises:
  • ESG disclosures help companies in identifying certain opportunities for innovation that might yield high results in the future.
  • ESG disclosures allow companies to identify potential transition risks, self-assess its ability to sustain in the future, and undertake necessary steps to adapt to the likely future changes.
• Improves customer experience:
  • ESG disclosures aid consumers in identifying responsible businesses, which not only concentrate on maximizing profits, but also on growing in a responsible manner.
• Investment Attraction:
  • ESG ratings are crucial for attracting investments focused on sustainability.

ESG Framework in India

• Existing Laws and Bodies:
  • Environment Protection Act of 1986 and National Green Tribunal regulate environmental issues.
  • Various labor codes and corporate governance laws govern social and governance aspects.
• SEBI’s Initiatives:
  • SEBI revised the annual Business Responsibility and Sustainability Report (BRSR) for the 1,000 largest listed companies.
  • BRSR mandates sustainability reporting with standardized disclosures on ESG parameters.
• Voluntary Nature of ESG Reporting:
  • ESG reporting is primarily voluntary in India, except for the top 1,000 listed entities.
  • It largely depends on businesses’ initiative.

Challenges in ESG Evaluation

• Diverse Metrics: Multiple frameworks use various metrics, leading to inconsistent evaluations.
  • Eg. Single vs Double Materiality:
    • Single Materiality: Focuses on risks to a company from environmental and social issues.
    • Single Materiality Limitation: This approach does not fully address the company’s external impacts.
    • Double Materiality: European regulators are shifting towards this approach, which also considers the company’s impact on the environment and society.
• Credibility Issues:
  • ESG ratings often differ significantly between agencies, aligning only about half the time.
• Inherent Hypocrisy:
  • Critics argue that ESG often prioritizes protecting a company’s financial interests over actual environmental or social welfare.
• Bundling Issues:
  • Combined Evaluation: Merging E, S, and G metrics can lead to confusing outcomes.
  • Example: Dow Jones Indices excluded Tesla from the Standard and Poor Sustainability Index while retaining Exxon Mobil, due to governance issues despite Tesla’s environmental contributions.
• Misplaced Focus:
  • The ESG framework may lead to superficial actions rather than addressing deep-rooted issues like climate change and inequality.

Moving Forward

• Reevaluating ESG: It’s time to critically reassess and potentially overhaul the ESG framework.
• Reducing Complexity: Simplifying ESG metrics can improve measurement accuracy.
• Domain Separation: There is a growing call to separate environmental concerns from social and governance issues for better clarity and focus.
• Focus on Emissions: Prioritizing emission reductions and environmental impact over broader social and governance issues.

Conclusion

The ESG framework’s inherent contradictions and challenges necessitate a reassessment to enhance its effectiveness. Unbundling the ESG elements to focus on critical environmental impacts can provide a clearer strategy for addressing pressing global challenges, particularly climate change, while still considering the importance of social and governance factors separately.

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Related Topics

Corporate Social Responsibility

The term “Corporate Social Responsibility” can be referred to as a corporate initiative to assess and take responsibility for the company’s effects on the environment and impact on social welfare.

• In India, the concept of CSR is governed by clause 135 of the Companies Act, 2013.
• India is the first country in the world to mandate CSR spending along with a framework to identify potential CSR activities.
• The CSR provisions within the Act is applicable to companies with an annual turnover of 1,000 crore and more, or a net worth of Rs. 500 crore and more, or a net profit of Rs. 5 crore and more.
• The Act requires companies to set up a CSR committee which shall recommend a Corporate Social Responsibility Policy to the Board of Directors and also monitor the same from time to time.
• The Act encourages companies to spend 2% of their average net profit in the previous three years on CSR activities.
• The indicative activities, which can be undertaken by a company under CSR, have been specified under Schedule VII of the Act. The activities include:
  
  
  • Eradicating extreme hunger and poverty,
  • Promotion of education, gender equality and empowering women,
  • Combating Human Immunodeficiency Virus, Acquired Immune Deficiency Syndrome and other diseases,
  • Ensuring environmental sustainability;
  • Contribution to the Prime Minister’s National Relief Fund or any other fund set up by the Central Government for socio-economic development and relief and funds for the welfare of the Scheduled Castes, the Scheduled Tribes, other backward classes, minorities and women etc.

References

UNIDO

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Related PYQ

Rehabilitation of human settlements is one of the important environmental impacts which always attracts controversy while planning major projects. Discuss the measures suggested for mitigation of this impact while proposing major developmental projects. [ UPSC Civil Services Exam – Mains 2016]

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Practice Question

The concept of ESG (Environmental, Social, Governance) has been integral to sustainable business practices for nearly two decades. Critically examine the inherent contradictions and challenges in the current ESG framework. [250 words]

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