Recent global developments such as extreme weather events and the outbreak of the Covid-19 pandemic, have brought to the forefront the vulnerability of businesses across the world and have provided an impetus to conversations around environmental, social and governance (ESG) parameters. Institutional investors, asset managers, financial institutions and even retail investors are increasingly demanding accountability from companies on how their businesses impact various pillars of ESG. ESG reports and disclosures (whether voluntary or regulatory) are increasingly being used to form a basis of decision-making by such stakeholders.
Current challenges with ESG reporting
The development of non-financial reporting relating to ESG across the world has been rather fragmented and inconsistent. While certain countries have developed (or are in the process of developing) their own reporting norms and taxonomies suited to their regional needs, many international bodies have come up with their own disclosure standards (such as those developed by Global Reporting Initiative, United Nations Global Compact, Task Force on Climate-Related Financial Disclosures, etc.) to be followed voluntarily. These norms are not always interoperable or comparable. This has resulted in information asymmetry among stakeholders and uncertainty in compliance by companies.
In light of the sharp focus on climate change and commitments under the Paris Agreement, several nations have taken steps to introduce laws to strengthen their ESG reporting framework.
The absence of uniform global standards is challenging for multi-national corporations and investors alike, who find it increasingly difficult to compare the sustainability measures adopted by businesses in differing geographies and industries.
Notably, the European Union (EU) has introduced several amendments to its regulatory framework on ESG reporting parameters over the years. These measures include (i) bringing sustainability reporting at par with financial reporting for businesses, (ii) mandating financial market participants to make the sustainability profile of funds more comparable and better understood by end investors, and (iii) providing taxonomy with appropriate classification for environmentally sustainable economic activities.
In the United States, the Securities and Exchange Commission has recently issued a proposal for amendments to disclosure requirements applicable to listed companies to enhance and standardise climate change-related disclosures. The proposal lays down specific information that listed companies will be required to disclose and is proposed to be implemented in a phased manner.
In Canada, the federal government has recently tabled a proposal requiring federally regulated banks and insurers to mandatorily report climate-related financial risks in accordance with the Task Force on Climate-Related Financial Disclosures.
In this context, the absence of uniform global standards is challenging for multi-national corporations and investors alike, who find it increasingly difficult to compare the sustainability measures adopted by businesses in differing geographies and industries. To highlight this complexity, we explore the key developments across the EU and India and discuss key issues that companies must watch out for.
Developments in the EU
Non-financial Reporting Directive and Corporate Sustainability Reporting Directive
In 2013, the Non-financial Reporting Directive (NFRD) was adopted by the EU to enable disclosures of non-financial and diversity-related information by certain large companies (covering approximately 11,700 companies and groups across the EU including listed companies, banks and insurance companies). Under this directive, these companies were required to disclose information relating to environmental matters, social matters, respect for human rights, anti-corruption and bribery, and diversity on company boards.
In 2021, a proposal on Corporate Sustainability Reporting Directive (CSRD) was adopted by the EU that amends the existing reporting requirement under NFRD to bring sustainability reporting on par with financial reporting. CSRD is yet to be approved by the European Parliament. The key changes proposed in CSRD are as follows:
- Scope of entities covered has been expanded to include all large companies, all listed companies in EU regulated markets;
- It requires audit of reported information; and
- It includes more detailed reporting requirements encompassing (i) targets in relation to sustainability matters and key performance indicators to achieve those targets; and (ii) actual or potential adverse impacts connected with the company’s value chain, its business relationships and its supply chain.
Developments under the EU Sustainable Finance Agenda
In 2018, the EU announced a Sustainable Finance Agenda as a part of the European Commission’s (EC) Sustainable Finance Action Plan. To make sustainability profile of funds more comparable and better understood by end investors across EU, the action plan includes the Sustainable Finance Disclosure Regulations (SFDR) and the EU Taxonomy Regulations (Taxonomy Regulations).
The SFDR, adopted in 2019, require certain sustainability-related disclosures from financial market participants (such as an investment firm providing portfolio management services or an AIF manager) and financial advisors (such as credit institutions, investment firms and AIF managers that provide investment advice). It requires them to publish written policies on integrating sustainability risks in their investment decision-making process and investment advice, respectively.
To address concerns around ‘greenwashing’ of financial products, the Taxonomy Regulations, adopted in 2020, provide stakeholders with appropriate definitions of environmentally sustainable economic activities by classifying and establishing a list of such activities. It objectively defines what economic activities are considered ‘green’, under the following four parameters:
- The activity should contribute substantially to one of the six environmental objectives set out in the Regulations,
- It should not significantly harm any other environmental objectives set out in the Regulations,
- It should be carried out in compliance with minimum social safeguards (such as compliances required under UN Guiding Principles on Business and Human Rights), and
- It should comply with certain technical screening criteria to be adopted by the EU. So far, EU has come up with technical screening criteria for two (out of six) environmental objectives.
Developments in India
In line with global developments, India has recognised the importance of a regulatory framework for sustainability disclosures. This is evident from the various steps that the regulators/ministries have taken in this direction. Some of the key developments that indicate the way forward that each of these regulators/ministries may adopt are discussed below.
Department of Economic Affairs
In January 2021, the Department of Economic Affairs, Ministry of Finance, Government of India, set up a Task Force on Sustainable Finance to put in place a framework for sustainable finance in India. It is also tasked with preparing a draft taxonomy of sustainable activities and a framework for risk assessment by the financial sector.
It is expected that the task force will provide recommendations to strengthen the resilience of India’s financial sector against risks emanating from various ESG issues and set a clear time frame for their implementation.
Reserve Bank of India
In May 2021, RBI set up a Sustainable Finance Group (SFG) to combat financial risks associated with climate change. This group along with other central banks, financial sector regulators and Government of India is expected to be instrumental in suggesting strategies and evolving a regulatory framework, including appropriate climate-related disclosures, for banks and other regulated entities to propagate sustainable practices and mitigate climate-related risks in the Indian context.
Mr. Rajeshwar Rao, Deputy Governor of RBI, has indicated that some of the initiatives that can be expected from the SFG include (i) integrating climate-related risks into financial stability monitoring, (ii) exploring forward looking tools like climate scenario analysis and stress testing for assessing climate-related risks, and (iii) analysing the issue of climate risks to financial institutions comprehensively and preparing a guidance note.
In January 2022, the SFG had undertaken a survey on climate risk and sustainable finance among 34 public sector banks, private sector banks and leading foreign banks in India and published the result of the survey on 27 July 2022. In its observation, SFG has noted that (i) almost all surveyed banks consider climate-related financial risk to be a material threat to their business, (ii) only a few banks had a strategy for embedding ESG principles in their business, and (iii) majority of banks have not aligned their climate-related financial disclosures with any internationally accepted framework.
- On 27 July 2022, RBI issued a Discussion Paper on Climate Risk and Sustainable Finance. In this paper, RBI has reiterated the importance of consistent and comparable climate risk-related financial disclosures and reporting by regulated entities and has recommended that at the minimum, regulated entities strive to make climate-related disclosures aligned with the recommendations of the Task Force on Climate-Related Financial Disclosures. It is also suggested that these disclosures be made annually to begin with and the ‘comply-or-explain’ approach be adopted.
Ministry of Corporate Affairs
- National Guidelines on Responsible Business Conduct: In 2019, the Ministry of Corporate Affairs (MCA) issued an updated set of guidelines called the National Guidelines on Responsible Business Conduct (NGRBC) containing a set of nine principles of responsible business conduct (aligned with the Sustainable Development Goals set out in the 2030 Action Plan proposed by the United Nations). These principles were expected to be adopted voluntarily by all companies. These guidelines also prescribe business responsibility reporting format containing disclosures required to be made against each principle. These disclosures were meant to serve as an internal tool for companies to assess their progress on sustainable business practices.
Report of the Committee on Business Responsibility Reporting: In May 2020, the Committee on Business Responsibility Reporting set up by the MCA (BRR Committee) published a report containing recommendations on Business Responsibility and Sustainability Reporting (BRSR) formats. The Committee has recommended two reporting formats, a comprehensive format (for listed and large unlisted companies) and a lite version (for smaller companies), requiring disclosures against the NGRBC principles. The committee has also recommended that (i) the reporting requirement may be extended by the MCA to unlisted companies above a specified threshold of turnover or paid-up capital, (ii) smaller unlisted companies below this threshold may, to begin with, adopt the lite version of the format, on a voluntary basis, and (iii) a five-year time period may be explored for phasing the implementation to cover all companies gradually.
While SEBI has issued a circular mandatorily requiring top 1,000 listed companies (by market capitalisation) to file BRSR, the MCA is yet to come up with any amendments requiring unlisted companies to prepare BRSR.
Securities and Exchange Board of India
- Taxonomy and disclosures for green bonds: In May 2017 (and subsequently updated in 2019), the Securities and Exchange Board of India (SEBI) has proposed its own taxonomy for issuance of ‘green bonds’, albeit with very broadly defined categories (such as climate change adaptation, clean transportation and energy efficiency). Separate disclosure requirements for issuers of green bonds have also been prescribed that include qualitative and quantitative performance measures of the environmental impact of projects to which proceeds of green bonds have been allocated, and methods and assumptions used in the preparation of such performance indicators.
- BRSR reporting for listed companies: In May 2021, SEBI passed a circular requiring top 1,000 listed companies (by market capitalisation) to mandatorily file BRSR, in line with the recommendation of the BRR Committee. The filing requirement is voluntary for financial year 2021-22 and mandatory thereafter. The format of the BRSR proposed by SEBI is largely based on the format proposed by the BRR Committee, that is, it requires companies to make disclosures against the nine NGRBC principles.
BRSR format is an interoperable framework and those companies which disclose sustainability reports based on internationally accepted reporting frameworks such as those developed by the Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board (SASB), etc., can cross-reference such disclosures in those sought under Indian law. This may help reduce the compliance burden for companies that are already preparing disclosures based on internationally accepted reporting frameworks as they do not have to disclose the same information twice while also providing global investors a useful comparative tool.
- Consultation paper on disclosures to be made by ESG-focused mutual fund schemes: In October 2021, SEBI issued a consultation paper proposing disclosure norms for mutual funds launching ESG Schemes. It is proposed that the scheme information document of such schemes include (i) the strategy followed by the scheme with regard to ESG standards that merit such nomenclature, (ii) material risks associated with the scheme’s focus on sustainability, and (iii) details of assets allocated towards securities following ESG themes.
- ESG advisory committee: As per a press release in May 2022, SEBI has constituted an advisory committee on ESG matters. The terms of reference of the committee include: (i) enhancements in BRSR, (ii) developing approach, indicators and disclosures for ESG ratings; and (iii) enhancing disclosures and other norms for ESG investing.
Key issues for companies in India
Cost of implementation
Adapting to the evolving reporting norms can be a cost and resource-intensive exercise for companies, requiring inter-disciplinary support within the organisation. While the top 100 listed companies (by market capitalisation) have been preparing Business Responsibility Reports (BRR) since 2012, the BRSR, which now applies to the top 1,000 listed companies, is a lot more comprehensive than its predecessor. MCA is yet to come up with any amendment to the Companies Act, 2013 requiring unlisted companies to prepare BRSR. If, however, the recommendation of the BRR Committee is accepted, unlisted companies exceeding certain thresholds will also be required to prepare BRSR, even the lite version of which is fairly comprehensive. For preparedness, companies may consider assessing these formats and the guidance provided to prepare BRSR.
International outreach of EU Regulations and Directives
The EU Regulations and Directives discussed above are bound to have a trickle-down effect on companies in India that interact with undertakings in the EU covered under these regulations and directives. For instance, export-oriented companies will need to consider the disclosures relating to value chain and supply chain that the EU undertakings may require. Companies offering financial products to financial market participants in EU will need to be mindful of disclosures that these participants are required to make and prepare accordingly.
Given the trajectory that regulators in India have followed in the last few years, it is likely that the regulatory regime around ESG compliance and reporting is going to be strengthened further and the scope of companies to be covered under these regulations will increase. It remains to be seen if these compliances (and to what extent) will be made voluntary or mandatory. Mandatory requirements will increase the compliance burden on companies. Voluntary requirements will be complied with only if companies see value in making such disclosures. The jury is out on whether ESG compliances have any positive real-world impact. While on one hand certain institutional investors and regulators have hailed these requirements1, on the other hand, certain experts have called it a ‘feel-good scam’2. Nonetheless, India has shown considerable seriousness in its ESG agenda which indicates that additional regulations in this space can be expected.
Given the trajectory that regulators in India have followed in the last few years, it is likely that the regulatory regime around ESG compliance and reporting is going to be strengthened further and the scope of companies to be covered under these regulations will increase.