ESG metrics – is your game on point?

With investments in ESG strategies growing to 42% from 2018 to 2020¹, it is a contender for investment options. The six Principles for Responsible Investment (PRI) developed by the investors, for the investors, are guiding principles for making investments in their best interest²:

1. Incorporate ESG issues into investment analysis and decision-making processes.
2. Be active owners of incorporating ESG issues into ownership policies and practices.
3. Seek appropriate disclosure on ESG issues from investee entities.
4. Promote acceptance and implementation of the Principles within the investment industry.
5. Work together to enhance effectiveness in implementing the Principles.
6. Report on activities and progress towards implementing the Principles.

IDENTIFICATION OF ESG ISSUES

The broad, non-exhaustive classification of ESG issues, are:

• Environmental: carbon emissions, waste management, water usage, and energy efficiency, for example
• Social: customer satisfaction, data privacy, workplace health and safety, and employees’ healthcare access, among treating customers and community fairly
• Governance: compensation practices, board composition, internal control processes, lobbying, business ethics and so on.

DISCLOSURE SUPPORT

The US Securities Exchange Commission (SEC) has placed ESG strategies high on its exam priority list. As reported in April 2021, the Division of Examinations issued a Risk Alert to highlight observations from recent exams of entities offering ESG products and services. Notably, the takeaways included:

1. Ensuring clarity and consistency in all disclosers
2. Matching the ESG plan and reality
3. ESG Compliance must be integrated

European Commission has also published non-binding disclosure guidelines for companies to make consistent and comparable disclosures.

India has introduced new ESG reporting requirements for the top 1,000 (by market capitalization) listed companies.

International Sustainability Standards Board (ISSB) aims to develop a common baseline for disclosure standard used globally.

IIM Ahmedabad recently announced the establishment of a research chair in ESG in collaboration with government-run National Investment and Infrastructure Fund Ltd (NIIF). A move to support structuring and crafting of a strategic roadmap for policy makers, practitioners, and students to evaluate and fill gaps in R&D.³

It is set up as a sovereign fund and registered with SEBI as Category II Alternate Investment Fund. NIIF provides long term capital for infra-related projects since 2015.

NIIF offers three funds:

1. Master Fund– Invests in infra-related projects to establish sector-specific companies in association with prominent companies
2. Fund of Funds– invests in funds managed by renowned fund managers as anchor investors or through JV with fund managers.
3. Strategic Fund– invests in equity and equity-linked instruments

The NIIF already has traction in national and international investors, Abu Dhabi Investment Authority, was the first international investor in Master Fund, invested USD 1B in October 2017. Asian Infrastructure Investment Bank announced to invest an amount of USD 200M in the NIIF. HDFC Bank, Axis Bank, ICICI Bank, and Kotak Mahindra Life make for the Indian cohort. March 2020 USD 100M investment was made by the Asian Development Bank in Fund of Funds.⁴

GoI is planning to issue USD 3.3B worth sovereign green bonds, wef., April 1, 2022 to promote low-carbon economy⁵

RISE OF ESG DUE DILIGENCE

Environment and societal factors have made it to the forefront in investment decision-making, at par with the accounting information and governance results. Corporates are also opting to voluntarily disclose their ESG efforts, which are reported using EGS metrices developed from the UN’s Sustainable Development Goals (SDGs)– which is to be fully attained by 2030.

A report published by S&P Global⁶ stated that in 2022, corporate boards and government leaders, being in a fiduciary role, will face rising pressure to demonstrate that they are adequately equipped to understand and oversee ESG issues — from climate change to human rights to social unrest.

A survey conducted by PwC⁷ highlighted ESG issues that were considered during the due diligence conducted for mergers and acquisition to identify reputational risks, opportunities to increase value post integration and areas for discounting price. ESG gains have also been a major contributor to the rise of Mergers and Acquisitions (M&A) in 2021 and in 2022 with an expected trend to continue, upward.

Per the survey, companies ensured the corresponding %, which is a part of due diligence conducted for M&A –

1. Environmental issues- 63%
2. Social issues- 44%
3. Governance issues- 38%

Considering the rise of M&A in emerging markets, governance issues of ESG are positively included in due diligence. This is going to become a matter of policy for corporates and cause for stakeholders to look at it with a serious lens.

The Russia-Ukraine invasion has resulted in, financial resources and employee support being restricted to Russia due to the impact on ESG’s social issues. The motivation for this is, the risk of major reputational losses on account of measurable ESG metrics.

VALUATION WITH ESG LENSE

While companies expect a discount for poor performance on ESG metrics, they are unwilling to spare a premium for the contrary. The good performance leads to willingness to go through the deal and an increase in brand value.

A large number of corporates are inclined to include ESG issues in a share purchase agreement (SPA) as an annexure, providing a detailed approach to the arrived valuation.

Sources:

1. The Rise of ESG and the Importance of ESG Data | Nasdaq
2. What are the Principles for Responsible Investment? | PRI Web Page | PRI (unpri.org)
3. IIM Ahmedabad, NIIF to set up India’s first ESG research chair (moneycontrol.com)
4. National Investment and Infrastructure Fund (NIIF)- Recent News, Investments by ADB, CPPIB (byjus.com)
5. India govt plans $3.3 billion sovereign green bond issuance (livemint.com)
6. Key trends that will drive the ESG agenda in 2022 | S&P Global (spglobal.com)
7. pwc-the-integration-of-environmental-social-and-governance-issues-in-mergers-and-acquisitions-transactions.pdf

This is only for informational purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavoured to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.