Impact of ESG based existing norms and emerging requirements of developed economies, on Indian economy

While global leaders are setting Net Zero targets, market regulators, businesses and investors too are not leaving any stone unturned to steer the world to a sustainable future. There is a gradual inclination of investment in assets that are responsibly aligned with Environmental, Social & Governance (ESG) requirements. The ESG assets under management is likely to surpass USD 50 trillion by 2025.

Governments around the world are introducing ESG based requirements, for instance European Union (EU-27) has introduced norms such as SFDR, CSRD, EU Taxonomy regulation, CBAM, etc. Similarly, the market regulators of US, France, Hong Kong, UK, etc. have also embarked on the journey of establishing ESG norms for investments and listed entities.

With such norms being laid down by major economies it shall have cascading implications on the global supply chain. In the business that is being outsourced by such economies, it would gradually become imperative for business houses in outsourced economies, to mitigate concerns arising out of ESG matters in their value chain.

Global ESG / Sustainability compliance norms

To align with the global commitment to combat climate change and create a future of sustainable co-existence , major economies across the globe have been adopting and laying multiple climate change and sustainability/ESG disclosure norms for their region-specific entities inclusive of value chain members and investors, to achieve their desired sustainability goals.

Disclosure norms concerning climate related risk & opportunities, carbon emission and waters footprint, decarbonization strategy, monetary liabilities or opportunities arising out of ESG matters, human & labour rights, sustainability due diligence concerning investments and other social and governance metrices are being drawn for implementation by progressive and emerging economies, in conjunction with some global frameworks, wherever felt appropriate. Some of the key compliance norms across major economies have been listed alongside.

European Union (EU)

1. EU – Taxanomy Regulation

The taxonomy regulation assists in identification and indicating whether economic activities adopted are environmentally sustainable or not. Identification of activity depends on –

  • Whether it makes “substantial contribution” to a series of
    environmental objectives,
  • No significant harm” to a series of environmental objectives,

It also requires organizations to meet some specific social & technical screening criterion.

2. Sustainable Finance Disclosure Regulation (SFDR)

The SFDR imposes Environmental, Social, Governance (ESG) disclosure regulations and requirements on financial market players/participants and products in European Union, with an aim to prevent greenwashing concerns and to increase the transparency related to sustainability claims made by financial market players. EU SFDR’s mandates disclosure of the manner in which such financial market players consider two key factors – (a) Sustainability Risks and (b) Principal Adverse Impacts in investments.

3. EU – Corporate Sustainability Reporting Directive (CSRD)

The CSRD is a successor to NFRD, which calls for increased disclosure requirements specific to ESG.

The CSRD requires the market participants to conduct double materiality assessment and report their ESG performance in accordance with European Sustainability Reporting Standard (EFRS), which is likely to be released by European Financial Reporting Advisory Group (EFRAG) very soon. The reports would also have to be subjected to third party independent audits. The CSRD mandate is likely to cover over 11,500 companies in the first year of its implementation, followed by another set of approx. 37,000 companies within the next 2 years.

4. Corporate Sustainability Due Diligence Directive (CSDDD)

The CSDDD proposal was adopted by the European parliament on 23 rd February 2022 with an aim to address human rights & environmental parameters and requires European Union organizations and its value chain members to conduct due diligence of the above-mentioned parameters.

It obligates organizations to identify, prevent, account and mitigate the negative impacts on human rights & environment. It further requires organizations and value chain members to align their business strategy with 1.5ᵒ C climate goals.

5. Carbon Border Adjustment Mechanism (CBAM)

The CBAM compliance norm has been necessarily brought in place to help European Union achieve its commitment under European Green Deal, to achieve emission reduction of 55% by 2030 compared to 1990 emission levels.

The CBAM requires European Union companies to manufacture as well as import low carbon emission intensive goods. The compliance norm would be effective from January 2023, which further implicates that the landing cost of goods in European Union covered under CBAM would be higher if they are not moving towards a low carbon pathway.

United States of America (USA)

US-SEC revised policy on Climate Disclosure

The US- Securities & Exchange Commission (SEC) proposed rules that would require public companies to disclose extensive climate related information in their SEC filings. It would require the companies to disclose –

  • climate-related risks that could reasonably have a material impact on a public company’s business, results of operations, or financial condition.
  • greenhouse gas (“GHG”) emissions associated with a public company that includes, in many cases, an attestation report by a GHG emissions attestation provider
  • climate-related financial metrics in the company’s audited financial statements.

United Kingdom (UK)

1. CP21/17

CP21/17 proposed by the Financial Conduct Authority (FCA) extends TCFD reporting requirements to asset managers, life insurers and FCA-regulated pension providers and includes disclosure of how climate change is considered in the selection of external managers. The proposal contains product-level, as well as entity-level, reporting requirements.

2. Sustainability Disclosure requirements (SDR)

It requires asset owners and investment managers to disclose the impact of ESG issues on investment risks and returns, as well as their investments’ impacts on society and the environment (consistent with the concept of double materiality).

Hong Kong

1. Principles of Responsible Ownership)

It is a voluntary reporting initiative that applies to asset owners and investment managers and is overseen by Hong Kong’s main financial regulator, the Securities and Futures Commission (SFC). The principles focus on stewardship activities, including proxy voting and engagement, and primarily cover the reporting of investors’ stewardship policy and its implementation.

2. Circular to management companies

It came into effect on 1 January 2022 and applies only to investment managers offering ESG-branded products that are authorised by the SFC. The obligations are similar to the SFDR’s product-level reporting requirements: for example, they stipulate disclosure of how ESG criteria are considered in the ESG investment strategy and how the fund has attained its ESG focus.

3. Management and Disclosure of Climate-related Risks by
Fund Managers

The SFC has decided to implement TCFD-aligned reporting requirements for investment managers, which is in due process.

France

1. Article 29 of France’s 2019 law on energy and climate

Updated in 2021, it applies to asset owners and investment managers and implements the SFDR’s reporting requirements at entity and product levels. However, the law goes further in certain areas and requires disclosure of biodiversity risks.

2. Décret n° 2015-1615, Décret n° 2016-10, AMF guidelines for
sustainable funds

These norms focus on –

  • providing assurance to investors that a product meets the espoused ESG promises,
  • minimum reporting standards for funds marketing themselves as ESG funds.

Implication of the norms on Indian Companies

The embracement of ESG requirements by the developed economies will have a varying level of implications for Indian entities, operating as value chain members (both upstream and downstream) to such the entities of such geographies, which have ESG mandates. Further, such norms would also have implications for Indian companies, seeking investments as well as for companies having operations in such geographies.

In the financial year of 2021-22, India accounted a total export of USD 395.41 billion and its trade relationship with developed economies such as European Union, France, United Kingdom, USA, Hong Kong accounted over 30% of its total exports. In the current scenario, wherein, China’s global export is almost 8.5 times of India, if India needs to capitalize on ‘China Plus One’ policy, in its journey to become a USD 5 trillion economy by 2030, then, India will have to align with such emerging ESG based business requirements, to become a preferred market. Companies based out of the ESG mandated geographies would be keen to partner with such entities that are in adherence with their ESG specific requirements.

In order to continue as a strategic trade partner for achieving sustained economic growth, through collaborations with such ESG mandated companies in the discussed geographies, Indian companies, at a broad level could earnestly consider acting on the following ESG matters.

  • Impact identification of climate related risks & opportunities,
  • Climate resilience study of business and integration of ESG metrices in business strategy,
  • GHG Accounting and Decarbonization strategy, in alignment with 1.5ᵒ C climate scenario & in accordance with SBTi criteria,
  • Address and mitigate significant sustainability risks and adverse impacts arising out of business activities,
  • ‘Double Materiality’ assessment to identify ESG matters material to its businesses,
  • Alignment of ESG performance with domestic & global frameworks, such as GRI, BRSR, IR, etc.
  • ESG assessment of supply chain,
  • Secure enhanced ESG rating from rating providers such as CDP, EcoVadis, DJSI, MSCI, etc.

 

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