ESG Investing in India: Navigating Environmental, Social and Governance Factors for Sustainable Growth

Environmental, Social and Governance (ESG) investing, also known as sustainable investing, represents an investment approach where funds are allocated to companies that comply with ethical practices alongside profitability. The ESG criteria evaluates how public companies uphold environmental responsibility, contribute positively to their communities, and maintain high standards of management and corporate governance.

Investors focusing on ESG criteria exclude stocks of companies that fail to meet specific environmental, social or governance standards. Examples include chemical companies responsible for significant pollution or firms with poor labour practices. The adoption of ESG investing principles

has been gradually increasing globally, with numerous investment funds integrating this approach into their investment strategies in recent years.

What is an ESG score, and how is it calculated?

A company's adherence to ESG standards can be assessed through an ESG score provided by

research entities such as MSCI, Sustainalytics and Morningstar. These scores, reflect a company's compliance with ESG criteria and are subject to changes in regulation and compliance and to

changes in a company's ESG efforts. While not obligatory, having an ESG score serves as a beneficial

metric for organisations.

Research organisations employ their unique evaluation frameworks to assign scores to companies and mutual funds. The MSCI ESG score assesses how effectively a company manages its ESG risks compared with others in the industry. Companies attaining AA or AAA ratings are recognised as ESG risk management leaders.

Morningstar's ESG score quantifies the ESG risks associated with a specific company or mutual fund on a scale from 1 to 50, where 1 represents the lowest risk while 50 is the highest. Additionally, Morningstar provides detailed scores for ESG factors.

Types of ESG Investing

ESG investing comprises various vehicles that are designed to align with ESG principles. Firstly, investors may choose ESG-compliant stocks, where companies comply with ESG norms and disclose sustainable practices and social initiatives on their websites. This allows direct investment without relying on mutual funds.

Alternatively, ESG funds offered by mutual funds provide diversified ESG portfolios. Investors can select high-rated ESG funds from the provider's list by utilising screening tools, ensuring a straightforward and secure investment approach.

Exchange-Traded Funds (ETFs) provide another avenue for ESG investments. These funds, traded on the stock market, pool funds from numerous investors to buy various tradable financial assets. ESG ETFs are focused on ethical investments, excluding sectors such as tobacco, weapons, and adult entertainment. This strategic exclusion protects assets from increased taxes and additional risks associated with controversial activities.

Lastly, ESG Index Funds track specific ESG indices, with notable options such as the Nifty 100 ESG Index, Nifty 100 Enhanced ESG Index, Nifty 100 ESG Sectors Leaders and S&P BSE 100 ESG Index, available in India. These index funds offer investors a benchmark for ESG performance in the market.

Driving Forces and Progress: The Evolution of ESG Investing in India

Several factors have contributed to the expansion of ESG investments in India:

These initiatives and measures have greatly contributed to the advancement of ESG investing in India and globally.

India's ESG Investment Landscape

Amid global challenges such as climate change, inflation, stimulus measures in response to COVID-19, armed and trade conflicts, and supply chain disruptions, India has shown notable economic resilience. Between 2012 and 2020, India introduced six ESG funds. According to the latest data, the country hosts 11 sustainable investment funds, comprising eight actively managed funds, one passive fund (ETF/ Funds of funds), and two global feeder funds. The actively managed funds represent 96% of the total Assets Under Management (AUM) in this category, with the top five funds accounting for 93% of the assets. Notably, the largest fund alone constitutes 56% of the total AUM.

Source: Groww
AUM as on March 3, 2024

According to recent guidelines from the Securities and Exchange Board of India (SEBI), ESG funds can now be established based on any of the following six strategies:

• Exclusion
• Inclusion
• Best in Class & Positive Screening
• Impact Investing
• Sustainable Objectives
• Transition-Related Investments

Asset management companies are required to allocate at least 80% of the AUM in equity or equity-related instruments under these categories. Additionally, ESG schemes must invest a minimum of 65% of their AUM in companies that engage in comprehensive Business Responsibility and Sustainability Reporting (BRSR) and provide assurance on BRSR Core disclosures. Mutual funds are also mandated to ensure that these schemes are different in terms of strategy and asset allocation.

The total AUM of ESG funds, which was US$ 331.4 million (Rs. 2,747.36 crore) as of January 31, 2020, has seen substantial growth over approximately four years, reaching US$ 1176.6 million (Rs. 9,753 crore) by March 3, 2024. This growth trajectory is led by the SBI Magnum Equity ESG Fund, which holds US$ 660.2 million (Rs. 5,472 crore) in AUM.

As the interest and capital inflows into ESG-compliant Indian companies continue to rise, stock exchanges have introduced specific indices to systematically track this trend. At present, there are four distinct indices, namely the S&P BSE 100 ESG Index, Nifty 100 ESG Index, Nifty 100 Enhanced ESG Index, and Nifty 100 ESG Sector Leaders Index.

Charting the Future: Policy Reforms and ESG Reporting Mandates in India

The last decade has seen a stream of policy reforms that have led to the greater inclusion of ESG in Indian organisations.

Business Responsibility and Sustainability Reporting

One of the latest ESG regulatory frameworks in India is SEBI's BRSR, introduced in 2021. These guidelines make it obligatory for the top one thousand listed companies to report on sustainability. The BRSR Core that covers the first 150 companies expects them to have an assurance by their FY24 annual report. This threshold is expected to include 250 more companies in FY25 and will eventually encompass the first one thousand listed companies by FY27.

One of the investment strategies, where ESG is considered a long-term measure, is an emerging product gaining investor confidence as the presence of such products is growing in the Indian market.

Future of ESG investing in India

Avendus Capital, a leading investment bank in India, has published a report stating that ESG factors are set to play a key role in the decision-making process of the Indian equity capital markets. The report forecasts that ESG could represent approximately 34% of the total domestic AUM by 2051. This increase is anticipated to be driven by sectors focused on ESG, such as renewable energy, electric vehicles, green hydrogen, and climate technology. The report suggests that the growth of ESG-oriented AUM in India over the next 5-10 years could mirror the Asia-Pacific region's ESG growth rate of around 30%, eventually stabilising to 15-20% by 2051. Furthermore, a significant portion of this growth will come from the reclassification of existing assets into ESG categories, particularly in firms that are proactively incorporating ESG principles into their operations. This trend is expected to be predominantly observed in three major sectors—banking, financial services, insurance (BFSI), information technology (IT), and healthcare—accounting for 35-40% of India's ESG-oriented business market share.

The push behind ESG investing in India is being driven by three main factors: India's commitment to achieving its 2070 Net Zero target, which is projected to necessitate US$ 8-10 trillion in capital expenditure over the next five decades; SEBI's introduction of BRSR mandates, providing a regulatory framework for listed companies to prioritise sustainability; and the United Nations' Sustainable Development Goals (SDGs) that is serving as a benchmark for measuring a company's attractiveness and capital-raising capacity. The report also notes that 2011 marked an important year for ESG and sustainability initiatives in India. It also highlights that governance within Indian corporations is receiving increased scrutiny from stakeholders, with an increasing institutional push for compliance among listed companies. Analysis reveals a negative correlation between the corporate governance score of S&P BSE-listed companies and stock beta, suggesting that companies with higher governance scores tend to experience lower stock price volatility.

Conclusion

The expanding ESG model in India reflects a strong path driven by regulatory, corporate governance scrutiny and strategic alignment with global sustainability goals. As ESG factors are increasingly determining investment decisions, the expected growth in ESG-oriented AUM aligns with India's commitment for a greener future. The ongoing trend, supported by strategic sectors and regulatory frameworks, positions ESG investments as a strong force in moulding India's financial ecosystem, contributing to a more sustainable and resilient economy for the years ahead.