Relevance: GS-2: Government policies and interventions for development in various sectors.

Key Phrases: Environmental, Social, and Governance, Credit rating agencies, Formal obeisance to the set standards, principles of capitalism, business compliance, green companies, high governance standards, environment or social responsibility.

Why in News?

• ESG is quite a buzzword today and the regulators and the regulated alike all looking to ensure compliance.
• New financial products have entered the fray and even the government had spoken of issuing green bonds in the Budget.

Need to unbundle ESG:

• ESG connotes three different, unrelated issues and ideally should not be looked at in unison.
• The reason is that the motivations and consequences of non-compliance have a different set of implications for society.
• Governance is a micro-level issue while the environment is global, as the consequences of climate change are now visible to everyone the world over. Social responsibility is more in the domain of ethics.
• Whenever there are compliance issues the attempt is to have objective yardsticks to measure them with the help of credit rating agencies such as CARE or CRISIL.
• But clubbing all three together runs the risk of bundling objectives that are diverse and could lead to convoluted results.
• Companies may have very high governance standards but could be environment unfriendly given the nature of the business and hence giving a combined measure of performance can be misleading. The solution is to unbundle these three and look at them separately.

Formal obeisance to the set standards:

• One of the negative outcomes with ESG is there is a lot of ‘washing’ that takes place in all the components.
• Washing refers to companies doing what is required to send the right signals to gain the favour of the evaluator while paying only formal obeisance to the set standards.
• Annual reports of companies have eloquent statements on how they comply with all the three objectives quite comprehensively.

Contradictions in Environmental compliance:

• A company that writes about the concern for the environment and speaks on the use of energy-saving bulbs or recycling of water. But the basic activity of a construction or chemical company would be highly polluting.
• Executives keep flying across the world for striking deals, and it is well known that air travel and the environment are always at odds.
• Use of bottled water is common in all companies which talk ‘green’. fancy glass buildings are known to be environmentally unfriendly but are the order of the day for all new commercial constructions. Such contradictions tend to exist in the ‘washing’ process.

Contradictions in social compliance:

• Companies are entities run on the principles of capitalism. Their job is to make good returns for the shareholders, and the rest becomes secondary.
• Normally, everyone would like to operate on the right side of law and regulation but the boundaries for that have to be defined. Most companies follow the law in letters but often not in spirit.
• The government has in the last few years made it also mandatory for them to keep aside 2 percent of their profit for social spending. Such activity is the job of the government and not companies, which are already paying taxes to the state.
• Yet, most of them do declare their spending on such activities in their Annual Report and often end up treating it as ‘business compliance’.
• Therefore, annual reports may not be the best source of information on the true nature of these activities.
• For companies, keeping special teams to tackle the environment or social responsibility merely increases their costs; this may not be the ideal way of achieving compliance.

Contradiction in Governance compliance:

• There are regulatory disclosures that ensure that there is the right composition of Directors and also that there is a certain level of attendance which is ensured.
• There is also a rule which makes Directors take a qualifying exam. Therefore, from the regulatory end, a lot has been done.
• Governance problems crop up when there are issues over ownership, when it is an unregulated entity, or when there is a crisis — as was the case in the financial sector including both banks and NBFCs. This is when it is realized that governance has been breached in spirit.
• At times a strong head of the organization or an owner gets in well-known names as Directors but ensures that they remain malleable to their wishes.

Complex exercise:

• Therefore, ESG evaluation is complex issue. Often, most companies pay obeisance to regulation and cannot be faulted. What is suggested is that these three objectives need to be evaluated independently.
• Environment compliance:
  • There need to be rigorous standards for environmental compliance which go beyond what is written in Annual Reports.
  • Practices pursued within the organization need to be studied through personal visits to gauge how truly ‘green’ companies are.
  • This can be done by rating agencies or research institutions which are paid by the government to ensure there is no conflict of interest.
  • They would be more like how regulators carry out inspections in the financial sector.
• Social compliance:
  • Social responsibility ideally falls outside the purview of capitalism as there are inherent contradictions.
  • Companies that build schools in villages see nothing wrong in laying off staff in the name of efficiency and hence make a mockery of the concept of social responsibility.
  • The government should instead increase the corporate tax rate by 2 percent and use this amount for fixed projects such as equipment in public hospitals, or furniture in village schools.
• Governance compliance:
  • Governance evaluation should be given the skip; while there are rules to be followed, it is hard to get everyone to follow in spirit.
  • What is more important is that when there are scams in companies, the Directors need to be moved out from similar positions in other companies. This can be a signal for performance.
  • Otherwise, these micro issues which pertain to companies are more internal in nature and need not be clubbed with the environment and social responsibility.

Conclusion:

• There is a need to segregate the ESG standards and check the compliance with each parameter separately because the societal impacts of each ESG standard vary in size. A combined ESG evaluation should not be undertaken, in any case.

Source: The Hindu BL

Mains Question:

Q. There is a need for change in environmental, social, and governance (ESG) monitoring systems as ESG goals are unrelated to each other. Explain.