With global warming, dwindling biodiversity and rising pollution threatening posterity and widening economic disparities, campaigns such as Race to Zero and the United Nations’ Sustainable Development Goals matter more than ever. Investors these days are conscious about where their money goes, and environment, social and governance (ESG) has evolved as a framework to back businesses that take the conscientious route to profits. ESG funds have found favour among investors globally because they help meet responsible-investing goals while entrusting the arduous stock-selection process to fund managers.
ESG funds are mutual funds or managed investment schemes that specifically take into account the ESG performance of companies when deciding the mix of stocks in the portfolio. An ESG fund may be actively managed, with fund managers cherry-picking the stocks, or passively managed like index funds or exchange-traded funds (ETFs).
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ESG funds have the potential to play a significant role in promoting sustainability measures. They are not project finance, meaning they may not back specific sustainability projects of businesses. Rather, they ensure funds flow to companies that are deemed well-governed and socially and environmentally responsible based on the ESG criteria evolved by fund managers.
The fund managers score these companies based on the data available from their sustainability reporting – including from the business responsibility and sustainability reports (BRSR) mandated by Sebi for the top 1,000 companies by market capitalisation. If such reporting is not available, they may seek information from companies to evaluate their ESG performance.
Baby steps
While ESG investing in India still in its nascence, the concept has gained ground globally. The assets under management (AUM) in sustainable investing has touched $30 trillion and is projected to grow further. In this context, providing an enabling ground for foreign investors to back sustainability oriented entities in India sounds fitting.
The International Financial Services Centre (IFSC) in GIFT City, Gujarat, is evolving as a centre for sustainable finance under the aegis of its able regulator International Financial Services Centre Authority (IFSCA). The latest IFSCA bulletin shows that the cumulative ESG labelled debt-listing in IFSC exchanges is over $14 billion as of September-end.
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Green/sustainable loans by international banking units in IFSC was over $1.5 billion in 2023-24, backing projects ranging from renewable energy, energy efficiency to social education and affordable housing. With India’s net-zero transition by 2070 requiring $10 trillion, and more required for the social sector, these may seem baby steps – but we are getting there.
Now, as a further measure to support and encourage sustainable finance, IFSCA said on 27 September that it will waive the filing fees for the first 10 ESG funds filed by registered fund management entities at GIFT-IFSC. A press release to this effect mentioned that one of the fund management entities has already availed of the incentive.
Prevent greenwashing
While these moves mark significant progress towards aligning fund flows with sustainability goals, the journey is fraught with challenges. Globally, even as the AUM of sustainability labelled funds has been touching new highs, the pace of growth has moderated. Though Europe and other non-US markets have witnessed growth in ESG investing, in the US, the concept has become politicised and is facing debates over its effectiveness.
It is important to maintain credibility by preventing greenwashing, in which entities only seem environmentally friendly but in reality are not. Ensuring the regulatory framework has robust safeguards backed by enforcement measures is necessary.
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Tracking the end use of funds may be simpler for green bonds as they are often tied to specific projects. ESG funds, however, usually invest in equity, and assessing how the investee companies adopt sustainability can only be done from a broader evaluation of their financial and ESG reporting.
Investors can take heart from Sebi’s mandate of obtaining assurance for the core ESG parameters starting with the top 150 listed entities from FY24. Adopting uniform taxonomy and strengthening the granularity of disclosures by ESG funds on the rating methodology can further deepen trust.
ESG investing matters to India, where both climate change and social inequity can have disastrous consequences, given the sheer size of the population. ESG funds could well accelerate the transition to sustainability, elevating it from a trend to the new normal.
Dr. Ranjith Krishnan is a sustainability consultant based in Thane and Usha Ganapathy Subramanian is a practising company secretary in Chennai.
