Is ESG investing in India practically feasible?

ESG assets under management in India have increased by four times in the last two years to touch Rs11,800 crore. Although a noble mission, practicing it is not easy. There are unique challenges in assessing compliance of the same by companies as well as in balancing the conflicts that routinely arise amongst the three aspects of ESG. However, these challenges do not take away from the fact that responsible investing is imperative.

Over the last decade, there has been a growing recognition of the fact that businesses have a responsibility not just towards its owners or shareholders, but towards all its stakeholders – these include customers, employees, suppliers, local communities and so on. The concept then found its way to the world of investing, giving rise to the practice of socially responsible investing (SRI). SRI typically employs a screening-out criteria and will eschew investments based on certain ethical guidelines – for example, avoiding investing in tobacco producers or makers of arms and ammunitions.

One variation or offshoot of SRI is ESG investing – that is Environment, Social and Governance investing. In ESG investing, unlike SRI, there are no blanket exclusions. Instead, it is a framework to first evaluate a company’s environmental, social and governance practices & risks and then using this evaluation to analyse the company’s value. The idea is that because a risk exists, it does not mean investors should completely avoid investing in the company. Rather, the risks should be incorporated while assessing the value of the company.

The importance being attached to ESG investing has been rising over the years and ESG assets under management are likely to touch $53 trillion by 2025 – representing more than one-third of total global assets under management. ESG AUM in India has reportedly surged four times in two years to Rs11,800 crore.

While there is no doubt that ESG investing is important, practicing it is far from easy and leads to some inconvenient challenges and outcomes – not just for the individual practitioner or fund manager, but also for the economy or society in which the fund manager operates or invests in.

The first challenge is the absence of standards that define ESG compliance and that allow comparative benchmarking for investors. Hopefully, as more investors embrace ESG investing, it will lead to the development of standardised disclosures and monitoring.

Governance, the ‘G’ in ESG, is arguably the more straightforward and least challenging aspect of this mode of investing. As a shareholder, one is very obviously concerned with issues such as the composition of the Board, the structure of the audit committee, transactions with related parties, levels of executive compensation and other aspects of governance that impact the interests of minority shareholders. These issues more directly impact the functioning of the company, and in turn have a bearing on the financial performance. As a result, focusing on Governance comes more naturally to investment managers.

The Environment and Social aspects are in some ways closely related to each other – pollution, for instance, is a serious social menace due to its immediate as well as long-term health hazards. However, in many other ways, both these aspects are also in conflict with each other, which makes assessing and factoring in the Environment and Social aspects in investing peculiarly challenging. The challenge manifests in two ways. First, analysing the financial impact of ‘E’ or ‘S’ is not easy. And the second, probably more serious issue, is managing the inherent conflict between ‘E’ and ‘S’. This issue is part of a more universal debate on managing development while protecting the environment.

Take for example, a coal-based power project seeking to raise funds for a new plant. In India, an average household receives 20.6 hours of electricity, with some rural areas getting as less as 16 hours a day. An ESG fund will probably not invest in such a project and this decision will comply with the ‘E’ part of ESG. But will it be a responsible decision to deny funding to a project that will help in reducing power outages and load shedding in a country where an average household goes without power for 4-6 hours every day? Obviously depriving a large section of the population with access to electricity is not socially responsible. How does a fund manager balance these two conflicting objectives?

One could say that by refusing to fund a coal-based power project, the fund manager is indirectly forcing the project developer to consider setting up power capacity using greener renewable energy. However, in a country where base load power itself is in deficit, increasing dependence on renewable energy has the potential to exacerbate power supply problems and even threaten grid stability. Wind power generation is not steady and solar power is unavailable during the evening peak hours. Replacing a power source that can run 24×7 with renewables, that generate power intermittently, is not a good idea at all.

The events that unfolded in Europe during the summer of 2021 bear testimony to this – high dependence on wind power (~ 20% of total consumption) meant that low wind output, amid issues in the supply of natural gas, led to a spike in wholesale electricity prices. Tariffs rose by 36% and 48% in Germany and France respectively, in just a couple of weeks in September 2021. Increasing electricity prices is surely a hit to the finances of regular households and is not very socially responsible.

Moreover, renewable power projects have their own inherent complications – both Environmental as well as Social. Utility scale solar projects are highly space intensive – requiring up to three to five times the land required for a coal-based plant. This land intensity has resulted in social conflicts in many parts of India, as marginal communities protest about land occupation (see here and here). Wind power has been objected to in many countries for reasons ranging from harm to birds from the rotating blades, to increase in noise pollution and clearing of woodlands (see here). How does a fund manager then be sure she is funding the right ESG compliant projects?

The reference to carbon emissions discussed so far is but an example. The challenge in ESG investing is more pervasive and extends to every funding/capital decision that seeks to balance the environment and social aspects.

Another thorny issue in ESG investing is that it’s hypocritical – both at the institutional and the individual levels. The institutional double standards stem from the fact that the largest providers of capital globally are based out of the developed world countries. The social good and higher standards of living achieved by these nations has come at a heavy cost to the environment and continues to do so – the EU, for example, has 7% of the world’s population, but uses almost 20% of the planet’s biocapacity. It is clearly unfair for such financial institutions to deny capital/funding to projects in the developing/ lesser developed world that would raise domestic standards of living. ESG investing, in a way has the potential to lead to exactly this.

At the individual level, the duplicity is of the fund managers. On a day I write up a report to refuse funding to a much-needed coal-based power plant, I may have driven to work in a nice car run on fossil fuel, sat in a comfortable, well-lit, air-conditioned office with back-up power from a diesel generator, and had a nice Italian lunch that had over half the ingredients imported. No matter that my decision is denying access to basic 24×7 electricity supply to many who badly need it.

The challenges do not dilute the relevance of ESG investing

Carbon emissions, whether in developing, or in developed nations, or whether in urban or rural India, harms the planet everywhere. Dumping effluents in a river in one country will harm marine life in oceans around the world. Any harm to the environment has eventual social implications in terms of health and safety for us and for the generations to come. A strong governance structure that balances social and environmental responsibilities of businesses is therefore an imperative.

At Marcellus, we believe that we owe a responsibility to all our stakeholders, including to the world we live and work in. And we also believe that we need to fulfil these responsibilities not just while building Marcellus as a business, but also when investing in other businesses. We think of ESG investing in terms of an expanding sphere of influence from local to global issues. Therefore, good Governance is managing one’s household (business) well. Social commitment is the obligation to manage the neighbourhood (community) well and environmental responsibility is managing the planet well.

Marcellus’ investment processes and frameworks already incorporate several Governance issues in stock selection. These include checks on accounting quality (please see our newsletters here and here, on the subject), disclosure standards, board composition and independence, leadership compensation etc. To strengthen our efforts towards responsible investing, we are also in the process of becoming signatories to the UN Principles for Responsible Investing (UN PRI).

The UN PRI is a United Nations supported network of investors, that works to promote sustainable investing. Our endeavour is to fulfil our fiduciary duty towards our clients while being more active owners of the businesses we invest our clients’ money in. We will seek to find the right balance between India’s social and economic development needs, and their impact on the environment. With our commitments under the UN PRI, we hope to join an increasing number of trustees of large pools of capital, in influencing a change in behaviour and actions that drive better outcomes for all stakeholders – the ones directly impacted by a business as well as those indirectly impacted.

Salil Desai is part of the Investments team in Marcellus Investment Managers (www.marcellus.in). He’s the co-author of “Diamonds in the Dust: Consistent Compounding for Extraordinary Wealth Creation”.