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Outlook on SEBI's new mandatory ESG reporting requirement

As India's 100 largest companies prepare to provide details on their sustainability and responsibility actions, a strategic assessment reveals that they are unevenly prepared to meet the new SEBI directive.

The SEBI board passed a resolution on Nov 24th requiring the largest businesses to describe measures taken by companies covering the key principles of the 'National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business’ framed by the Ministry of Corporate Affairs (MCA).

cKinetics, a sustainability consulting firm, issued a briefing note that outlines the opportunities for Indian public equities for leveraging this initiative for a competitive advantage. Its briefing examines the current policy framework in India related to Business Responsibility reporting, especially the National Voluntary Guidelines on Responsible Business and elucidates the need and drivers for business sustainability reporting. The paper also describes the state of Business Responsibility reporting of large Indian public equities and presents the findings of study which aimed to analyze the disclosure levels of Sensex companies with respect to National Voluntary Guidelines on Responsible Business.

Background: NVG-SEE
The National Voluntary Guidelines for Social, Environmental and Economic Responsibilities of Business (NVG-SEE) were released by the Ministry of Corporate Affairs , Government of India, in July 2011. They outline principles for responsible business action and provide guidance for the implementation of the same.

These guidelines have been formulated to encourage adoption of sustainability reporting and mainstream disclosure on environmental, social and governance metrics in India. NVG-SEE provides businesses a framework which enables them to move towards responsible decision making and urges them to adopt the “triple bottom-line” approach.

SEBI has, in the recent years, laid increasing significance on disclosure of non-financial measures and has lent support to ESG disclosure and standard setting initiatives. As per SEBI’s regulation under clause 49 of the listing agreement all public equities are required to comply with certain disclosure norms related to corporate governance. SEBI’s decision to get the largest businesses to adopt the NVG-SEE is a reaffirmation to continue to raise the bar for disclosure and drive transparency in the marketplace.

The national voluntary guidelines consist of 9 core principles, namely:
Principle 1: Businesses should conduct and govern themselves with Ethics, Transparency and Accountability
Principle 2: Businesses should provide goods and services that are safe and contribute to sustainability throughout their life cycle
Principle 3: Businesses should promote the well-being of all employees
Principle 4: Businesses should respect the interests of, and be responsive towards all stakeholders, especially those who are disadvantaged, vulnerable and marginalized
Principle 5: Businesses should respect and promote human rights
Principle 6: Business should respect, protect, and make efforts to restore the environment
Principle 7: Businesses, when engaged in influencing public and regulatory policy, should do so in a responsible manner
Principle 8: Businesses should support inclusive growth and equitable development
Principle 9: Businesses should engage with and provide value to their customers and consumers in a responsible manner

To read more on the Reporting Process under NVG-SEE, check out our previous article on National Voluntary Guidelines for India Inc.: from CSR to Responsible Business.

Need and drivers for Business Responsibility reporting
All stakeholders including investors, government and consumers are putting pressure on companies and demanding a performance report of companies’ activities to ensure they are not detrimental to environment, society or employees. Business valuations will differ if they reflected all the environmental, social and governance (ESG) risks along with economic performance.  Business Responsibility reporting seeks to fill this gap between corporate financial performance and a company’s true performance which takes into account non-financial metrics also.  It will measure, track and report a company’s performance on non-financial metrics such as environmental, social and governance (ESG) parameters.

The need for Business Responsibility reporting is not only for external shareholders but also for management and the board to better understand the true drivers of long term stakeholder value and to gain more insight into their company’s strengths and weaknesses.  It helps the company identify its operational shortcomings and inefficiencies which can then take appropriate steps to improve its internal systems and processes. Peter Drucker’s axiom, “what gets measured, gets managed” aptly summarizes this point. Sustainability reporting is needed to instill confidence in a company’s stakeholders about its long term sustenance and give a license to operate.

Drivers for adoption of Business Responsibility reporting comprise of both pull and push factors. Stakeholder groups such as investors, customers, etc. can demand greater level of disclosure and encourage companies to adopt non-financial reporting. On the other hand, regulations and compliance standards such as those by stock exchanges, government regulatory bodies etc can act as another driver for adoption of sustainability reporting.

International drivers for Indian businesses
•Global presence: Indian companies which aspire to expand their footprint to new markets and compete globally have to address the risks and competition in the international arena. For flagship sectors such as the Information Technology, already many global customers are asking to see the Business Responsibility or Sustainability Reports as a qualifier to do business.
•Attract capital: Another major international driver for domestic businesses to adopt Business Responsibility reporting is to attract the interest of foreign investors who are looking to invest in Indian companies which fare well on non-financial metrics as well. Also, a desire to list on a leading international stock exchange can greatly influence a company’s disclosure levels on sustainability.
Moreover, with the dialogue on climate change getting focused on emerging economies such as India and China, domestic companies will come under increasing pressure to report on non-financial parameters especially related to environmental impact. 

Domestic drivers
Other drivers which will significantly enhance the adoption of Business Responsibility reporting include:
•Regulatory framework - regulation either from a government body or from stock exchanges mandating disclosure of non-financial metrics is one of the biggest drivers for Business Responsibility reporting such as the recent SEBI regulation.
•Competitive advantage – By driving reporting, a company can use it to integrate sustainability into its core operating strategy which in turn can help build a competitive advantage through resource conservation, employee retention, better risk management, etc.
•Reputation - Extensive media coverage and increased NGO activism has awakened businesses to the need of incorporating sustainability practices and systems. A positive brand image with regards to sustainability can help companies attract premiums for their products and services and foster brand loyalty.

Current disclosure levels of BSE Sensex
Recently (in July 2011) cKinetics conducted a strategic assessment of the current disclosure levels of India’s leading companies across multiple sectors to gauge the current level of preparedness of India Inc. on Business Responsibility reporting. As part of the work, the companies comprising the Bombay Stock Exchange Sensex (BSE 30) were reviewed for their current disclosure levels viz. the reporting framework suggested by the NVG-SEE. These 30 companies account for INR 28,218 billion market capitalization(as on July 22, 2011) representing almost 42% of the total market capitalization of companies listed on the Bombay Stock Exchange.

The study calculated the disclosure score for all the 30 companies which constitute the BSE Sensex.  The NVG-SEE was used as the framework to map the disclosure levels of Indian companies. The NVG-SEE framework has 36 parameters reflecting nine key principles related to responsible business practices.

The data was collated from publically available information through company annual reports, sustainability reports and company websites. (It should be noted that the study has adopted the NVG-SEE framework as- is and has not considered materiality of parameters with respect to different sectors. This implies that some parameters may not be relevant for all sectors and disclosure score of companies in certain sectors may not be accurately reflected.)

The disclosure score varied across a wide range for these 30 companies, from 19% to as high as 78%. (It should be noted that till the most recent annual disclosure, companies were not required to provide this data and that the responsible business guidelines were announced only in July 2011) 

Disclosure score follows a sectoral trend


Source: cKinetics analysis

It has been observed that companies in Banking and Telecom Services industry have the lowest disclosure score and those in the FMCG industry (personal products, cigarettes and tobacco products) have the highest disclosure score. The IT Consulting & Software companies also have a reasonably high score. In the Automobile Industry, there is a clear distinction between disclosure scores of 2/3 wheeler companies and those of car and commercial vehicle companies with latter having a much higher score.

Governance
The study found that typically these companies have a high disclosure level regarding governance issues. Almost all the 30 companies disclosed information about the governance structure, constitution of the board of directors, responsibilities of the board members as well as the sub-committees, internally developed code of conduct and ethics etc.  However, while the frequency of the boards meetings seem to be of a high order, it is not clear as to the extent the board reviews sustainability performance and / or sets guidelines for formulating sustainability strategies. Furthermore, no information exists on mechanisms available to shareholders and employees to provide recommendations to the board/ Chief Executive.

Disclosure on governance parameters   
 
rce: Source: cKinetics analysis 

Employee welfare and stakeholder engagement
With regards to parameters related to employee well-being, the study determined that the disclosure levels are not very high. . Though almost all companies report their total employee strength, hardly any mention is made of the split between permanent and contractual employees. Additionally, only 8 companies were found to report the break- up of employees by gender and only 4 disclose the number of persons with disability, who form a part of their workforce. More than 50% of the companies have provided details of training programs carried out during the year but a standard metric is not used for disclosing such information. A little over 50% of the companies studied make explicit mention of observance of human rights in their operations. There is very poor disclosure w.r.t. wages and salaries of skilled and unskilled employees. In their disclosures, none of the 30 companies have reported any incidents of delay in payment of wages.

Stakeholder engagement is a mixed bag with half of the companies providing insight into their stakeholders and the nature of engagement with them. However, there is almost no disclosure about issues on which formal dialogue has taken place between the company and its stakeholders.

Environment
India has no mandatory environmental reporting for listed companies though the Companies Act (1956) requires companies to disclose details regarding energy conservation measures undertaken by them in their annual reports. 26 out of 30 companies surveyed have listed energy conservation measures adopted by them and the remaining 4 have explicitly stated in their annual reports that this parameter is not material to their business and hence not applicable to them. Though many companies report their total energy consumption, very few disclose the percentage of renewable energy used, if any. As is evident from the chart below, very few companies disclose the percentage of recycled materials used as input raw materials. Just about 50% of the sample companies typically provide details of efforts undertaken on reconstruction of bio-diversity and mitigation of adverse impacts of GHG emissions arising from their business operations and total water consumption.

Disclosure on environmental parameters  
 
Source: cKinetics analysis

Community engagement and customer value
 All 30 companies in the Sensex do believe in inclusive growth and make adequate disclosures about community investment and development work undertaken by them on account of fulfilling their corporate social responsibility. Amongst the various principles elucidated in the NVG-SEE, inclusive growth is the only one for which there is 100% disclosure amongst the BSE-30 companies.

On the other hand, there is almost negligible disclosure on product labeling effort including information regarding customer health and safety, method of use and disposal etc. Although one needs to keep in mind that this parameter may not be material for all the companies.

The way forward for Business Responsibility reporting
As outlined earlier, disclosure regarding the environmental, social and economic responsibilities of business has multiple benefits in terms of enhanced revenue growth and market access, cost savings, increased access to capital, better risk management and improved brand value and reputation.

For ESG disclosure to become useful in the main-stream, it needs to be accepted by the multiple stakeholders involved: businesses (of course), investors, policy makers and non-government actors. A few key parameters that need to be addressed are outlined below:

Format standardization - A standard framework accepted by all stakeholders for presentation of sustainability performance will allow for the disclosure process to become more meaningful.
       ~Comparability - Metrics which define ESG performance need to be comparable across companies which will help determine the relative standing of a company amongst its peers.  Like performance can be compared across companies in the case of financial reporting, Business Responsibility reporting also needs to incorporate metrics which lend themselves to comparison. 
      ~Complexity – Financial reporting is much more mature and, thus comparatively easier to capture. ESG related issues are complex, which makes their quantification, assessment and integration into decision making a difficult process. However by having standardization within sectors, a lot of the complexity can be avoided.

Materiality – Another area to be addressed in the measurement of non-financial performance is creating an objective process of determining which ESG issues are material. Materiality may vary across industries and to some extent even across companies within the same industry.

Reliability - Third party assurance for Business Responsibility is will need to get addressed to ensure veracity of data disclosed by the management. This will particularly be important to increase investor interest.

•Management systems – Unlike financial reporting for which tracking and measurement systems are in place; data collection with respect to performance on sustainability issues is challenging and requires capacity building and coordination amongst various departments of the organization. Data sources for Business Responsibility reporting are diverse, inconsistent and systems for consolidation and reporting are less automated.

Though uptake of Business Responsibility Reporting by Indian companies has been a slow in the past, the new SEBI regulation is likely to provide the necessary impetus and increase adoption of the National Voluntary Guidelines of business responsibility. This would hopefully be the beginning of a trend with companies realizing the importance of integrating sustainability into their core business philosophy and enhanced disclosure of the extra financial metrics related to environmental, social and governance performance.  

To read the complete briefing paper, click here.

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Author: sustainabilityoutlook