CONTENT SUPPORT BY:
Sandeep Bhattacharya, Climate Bonds Initiative - India
ESG investing has become a part of the mainstream of the global financial system and hence an integral part of asset management. Besides these funds in the west, funds dedicated to investing in locally-dedicated Emerging Market (EM) funds are becoming more popular and recently a few ESG labelled funds have come up in India. These funds integrate ESG factors into investment decisions, and are shifting from what they earlier were perceived to be a “check box” to being purposeful and even in some cases advocating that ESG be integrated in the business strategy of the investees. Hopefully, this will bring it close to the concept of sustainable development as espoused by the UN Sustainable Development Goals (SDGs). With the greater flow of capital into these funds, ESG investing can hopefully play a significant role in the UN goal of achieving SDGs by 2030, which is currently not on track. The target to meet SDGs investments is $2.5tn annually. Government investments and multilateral development banks (MDBs) funding alone cannot cover this gap and thus the role of private investments in this cannot be underestimated.
The recent ESG fund launched by some of the large fund houses in India means almost USD 19 billion of funds have flown into funds dedicated to ESG this year, which is almost double of what we have observed last year. One of the major reasons for such a large inflow even in the uncertain economic times of the pandemic is the performance of such funds. In a year's time frame, they have outperformed S&P 500 by 200 basis points. Globally, as of December 2019, there were 3,308 funds, which were into ESG investing. This number was 1,168 a decade back. The Paris Agreement in 2015, which saw policymakers from both Developed Market (DM) and EM countries commit to limit the global temperature rise this century to below 2°C above pre-industrial levels, was a turning point. The transition required to meet the Paris Agreement touches all major sectors of the economy—energy, agriculture, industry, transport and infrastructure—such that it has essentially blown open the ESG market globally. While equity dominates the ESG market with around half of total AUM, ESG-focused fixed income is gaining momentum—particularly green bonds issued by corporates and sovereigns in both DM and EM countries.
Multilateral Development Banks have been following the principles of ESG for quite some time now – and the principles have been embedded in their decision-making process. Often, there is some kind of due diligence on ESG factors at the pre negotiation stage. ESG is seen as an investment and not as a cost, which pays off in the long run, due to the reduction of various risks and therefore a better functioning of projects. A study by one of the leading Consultants indicates that 46 % of project delays happened because of non-technical issues, like social issues, land access, extreme weather conditions etc. Situations linked to climate change have an impact on other things as well. Flooding, availability of water, vulnerability to cyclones etc can very often lead to community pushbacks and operational disruptions. Looking at these issues right at the screening stage gives a much better idea about how disruptions in project execution or functioning after commissioning can happen and thus helps plan to mitigate the same. As a result of these mitigants being built into the project, long term benefits are accrued, given better functioning of the project. Innovative ways in which ESG best practices are carried out were discussed, such as setting targets to achieve zero fatalities on a highway asset rendering it to be a preferred usage route, thus having a positive effect on toll revenues. Having women only toll plazas, installing bio toilets instead of the normal toilets and also installing solar panels in various toll plazas and some available land. The combined effect of all of this is better local community engagement- and in the case of using solar panels, a reduction in costs, both adding to operational efficiency. A critical factor leading to the implementation of this has been building in ESG parameters in employee performance assessment.
The question then arises is that these kinds of measures, while beneficial for the operations, involves spending money- and how does one reconcile these with competitive bidding and the fact that the bidder at the lowest cost always has a high chance of winning the contract? The answer seems to be that incorporating ESG factors would imply a stable business performance over a period of time, and the same implies healthy business margins. Thus, incorporating ESG norms would mean that one would forego opportunities which might look tempting initially, but will create issues with operations in the long run, including cash flows shortages leading to disruptions.
While stressing on ESG factors often leads to better operational performance, it does not mean that implementing ESG norms does not have its own shares of challenges and pitfalls. There are many situations when a considerate developer runs into situations where the counterparty is keen to take undue advantage of the inclination of the developer, including trying to jack up land prices, and trying to negotiate other forms of compensation which was not justified etc.
ESG Funds are growing, both in terms of number of funds as well as the quantum available. Besides the growing corpus of funds in India, huge amounts of liquidity in the offshore funds can open up to developers who have followed norms of ESG when developing the portfolio of projects. In the western world, consistent and growing investor inclination has prompted even an entity as conservative as Bank of England (Markets executive director Andrew Hauser) stating that 'greeniums' or (premiums for green bonds over their vanilla counterpart) reported on the recent green bond issues were an "encouraging sign" that climate-positive investment was being favoured by the market. Hopefully, the quantum of responsible funds in India also grows to a level soon, so that the ESG friendly investments become perceptibly “favoured” by the financial market.
So, what role can investors play to drive their agenda? While doing their due diligence, having robust norms about parameters and also sometimes persuading for action in investee companies is one way, examples also need to be set within the organization about following the required norms. Practices such as variable compensation linked to carbon reduction targets, and focus on diversity & inclusion across the board members and linking compensation of executives to carbon emission reduction of the portfolio of investee companies.
One of the main challenges for a developer is to interpret the definition of ESG compliance. The definitions often have large overlaps with labour law requirements, and other regulations, thus embedding ESG norms would not necessarily mean many separate requirements. To become ESG compliant would generally mean a top-down approach, meaning that the developer builds and operates all projects with ESG approach and not be selective about this, thus making it an integral part of the company culture.
While the MDBs have taken a lead in pioneering ESG Investing, the growing corpus of such funds augurs well for the sustainable development challenges faced by the world today. Developers will need to work in synchronisation with investors in setting examples and help in achieving the UN SDGs.