Explained: Green Finance and ESG Goals in India Part - 2

Yesterday, we discussed the evolution of sustainable and green finance. In the second part, we will talk more about ESG goals, the status of green finance in India, and its significance.

If you have a limited understanding of green finance, we recommend checking out part 1. Otherwise, continue reading the second part.

As mentioned in the previous article, India has committed to net-zero emissions by 2070. Yet, the estimated economic growth of India presents huge challenges to this goal.

The Need for Green Finance

The effects of global warming and climate change are no longer subtle. The increasing temperature of our planet has threatened every life form on Earth.

Climate changes have occurred naturally throughout history. Yet, since the beginning of the 19th-century, humans’ emissions of greenhouse gases have increased the rate of this change.

The UN Environment Programme estimates that the temperatures worldwide can increase by over 3° C if we continue our industrial practices. Such an increase in the temperature can cripple our economies, disrupt businesses, and push more people toward poverty (1).

If this continues, we can face a loss of about 10% of the total economic value and wipe off as much as 18% of the world GDP by 2050, suggests the Swiss Re Institute (2).

These economic value loss doesn’t bode well for India. We aim to almost quadruple the size of our economy to 10 trillion USD by 2030, from about 3 trillion USD at present.

Hence, it has become necessary for India to achieve its net-zero ambitions.

As a part of the goal, our honorable Prime Minister Narendra Modi outlined ambitious aims for India. He has committed to producing 500 GW of energy from green sources by 2030 and reducing about 45% of our country’s carbon intensity. Also, India has committed to reducing its projected carbon emissions by 1 billion tonnes before the end of this decade.

According to the India CSR network (3), India needs 20 billion USD worth of investments every year to meet its climate targets. To fund its green transition, India will need a large budget allocation, green private investments, and international finance from bilateral and multilateral sources.

Another report from the CEEW, Council on Energy, Environment, and Water, suggests that India will need over 10 trillion USD investments to achieve its net-zero goals. But, the same council estimated that India is at risk of facing a shortfall of 3.5 trillion USD in its net-zero goals.

Thus, Indian corporations and financial institutes must help India meet these targets and plug any gaps.

Simultaneously, it is also crucial for banks to fight climate change as they are on the frontline in facing the impacts of the crisis since estimates suggest that the FSI would account for a huge 72% of climate change’s total potential financial impact.

India’s Efforts Towards Green Finance

Map of the Policy and Regulatory Framework for ESG Investment in India, Source: ADB.org

India has come up as a huge market for investors seeking assets per the Sustainable Development Goals. However, upon close observation, you can notice that the incorporation of ESG factors is yet to be fully developed in India.

The coronavirus pandemic further highlighted why sustainable practices need to be central to our economic practice and financial thinking.

India made its first efforts to connect finance and social and environmental issues in 2008 when the RBI issued a circular to raise awareness about the growing prevalence of CSR, corporate social responsibility, NFR, Non-financial reporting, and sustainable development worldwide in the Indian banking sector (4).

Since then, India has made two vanguard actions to push its green finance agenda:

Improving corporate disclosure on capital markets
Growing issuance of green bonds

The MCA, Ministry of Corporate Affairs, has made stellar performances in promoting sustainable investments by producing publications and guidelines for businesses to adopt the Principles of Responsible Investment. India’s capital market regulator SEBI has also supported efforts of the MCA via its regulation on the ESG investment matters in India.

On top, the Indian government has also formed an industry representative body, IIC, Impact Investors Council, to drive impact investments and represent impact investors in India.

To build on the worldwide momentum behind corporate disclosure, SEBI, the Securities and Exchange Board of India, introduced a requirement for the top hundred companies in terms of market capitalization to issue BRR, Business Responsibility Reporting, in 2012.

The BRR has nine principles, including:

Ethics
Product lifecycle
Employee Wellbeing
Environmental Strategy
The company’s membership in any trade association
Delivery of inclusive growth
Customer focus

Since 2016, the total number of companies involved in BRR has grown from 500 to 1,000 (5).

While analyzing the reports 100 of these companies submitted, the NSE National Stock Exchange found notable progress on some of these principles between 2017 and 2018.

For instance, 87 of those 100 companies had found environmental risks and 99 companies made employee disclosures.

While SEBI doesn’t need a BRR audition at the moment, the NSE study noticed that about 70% of companies reported independent audits on the nine principles (6).

If India wants to make the BRR more than regulatory compliance, there is a need to show the link between better BRR scores and improvements in financial performance. Overall, there are promising signs of a surge in ESG funds that adopt strategies like norm-based screening, and stakeholder action is gaining traction in our country.

At least five Indian institutes have also signed the PRI, Principles for Responsible investments:

SBI Funds Management
ECube Investment Advisors
Indus Environmental Services
Equicap Asia Management
Malabar Investments

After the first issuance of green bonds by Yes Bank in 2015, India emerged as the second-largest emerging green bonds market, with more than 7.2 billion USD in issuance (7, 8). Most of these funds have been used in renewable energy projects. These bonds also help reduce the maturity mismatch, and so far, they have been popular among issuers in India.

Another positive trend is the high demand for international bonds, which have been oversubscribed two to three times in several cases. These bonds are comparatively large ticket sizes and could attract investors because of their higher coupon rates (9). Still, these issuances are small to meet India’s green finance requirements.

Hence, to help the market growth, SEBI issued guidelines in 2017 to offer definitions and securities and laid down disclosure requirements (10).

In addition to principles and guidelines, the Indian government has undertaken several initiatives to mainstream ESG in our country.

For instance, in 2015, RBI reported the inclusion of lending to social infrastructure and small-scale renewables within its priority sector lending items. It increased impetus by doubling the loan limit to these sectors to 300 million INR in 2020.

If you look closely at the policy and legal framework around ESG investing in India, you will notice that:

The scope of these policies has evolved over the years in line with the rising emphasis on ESG integrated investments
These policies and regulations have become stringent, moving from a voluntary regime to a mandatory
There has been more emphasis on disclosing information for corporations

ESG Investment in India

Even though ESG investments have been evolving rapidly, they are still at a very nascent development stage in India. And considering our developmental priorities, it has become crucial for India to integrate ESG elements into its investment decisions.

While we are at government initiatives to promote green finance, it is also worth noting some of our corporate leaders’ sustainability initiatives.

One such initiative is the participation of our corporation in the RE100 global movement, which urges businesses to go green. It is in line with the business value proposition of corporations in India since industrial electricity consumption makes up more than 40% of India’s total electricity consumption (11).

Indian businesses like Infosys, Dalmia Cement, Tata Motors, and Mahindra & Mahindra are part of RE100 and have voluntarily committed to source their energy from renewable sources. For instance, Dalmia has committed to using renewable energy sources entirely by 2030 (12).

It suggests that Indian businesses have realized the imperative of seizing the opportunity to tap renewables. Consequently, more and more entities are adopting this pathway.

Likewise, Indian companies are also performing well under the corporate renewable PPAs, power purchase agreements. Several Indian corporations have become part of the Dow Jones Sustainability Index for emerging markets.

It includes businesses like Godrej Consumer Products, Mahindra & Mahindra, Tata Motors, Infosys, Havells India, Glenmark, M&M Financial Services, Tech Mahindra, Tata Steel, and Wipro (13, 14).

These companies are taking initiatives to generate energy from waste and other measures to reduce their dependency on fossil fuels. By integrating green energy into their operations and undertaking energy efficiency principles, Indian companies are committed to reducing their overall carbon footprints.

Besides major corporations, asset management companies like Axis Mutual Fund, Aditya Birla Sun Life, and ICICI Prudential are increasingly integrating ESG factors into their business decision-making process (15).

Better ESG Equates to Better Performance

Information from NSE highlights that ESG indexed businesses have done well than non-ESG indexed companies (16).

A study that evaluated 50 Indian listed companies revealed that companies had performed better in terms of policy disclosure than other ESG factors. It also revealed that governance is the most prominent of all ESG factors, whereas social factors had the lowest priority.

In addition, the top three companies of these 50 companies were in the automobile, chemicals, and consumer goods industries.

At the same time, companies operating in metals and mining industries were among the bottom most in terms of performance.

Indian Companies’ Average Score for ESG Factors

Comparative Performance

A comparison between the MSCI India ESG Leaders Index and MSCI revealed that ESG integrated organizations had performed better. In addition, the performance of ESG integrated entities continued to perform better even during the coronavirus pandemic (17).

Several key companies like Asian Paints, HCL tech, Nestle India, Axis Bank, Infosys, TCS, and Reliance Industries are positioned high on the MSCI Indian ESG Leader Index.

And if we compare the ESG performance of companies based on sectors, we can see that the IT industry has emerged as a leader, with about 26% weightage, followed by the energy sector, 25%. Hence, we can say that the IT and energy sectors effectively integrate ESG factors in their investment plans and decision-making processes compared to other industries.

Impact investing is another related area that has experience developments in India. As per the available data, impact investors collectively raised capital of about 11 billion USD in the past decade, between 2010 to 2020, covering over 550 businesses and effective almost 500 million beneficiaries (18).

These beneficiaries mainly come from low-income communities. Key industries attracting impact investors include health, education, agriculture, energy, technology, etc. (19).

Moving Towards Green Finance: What’s Next?

Green finance is a systematic program that involves multiple stakeholders like financial institutes, governments, regulatory bodies. Besides framing the policy framework and guidelines for green finance, we will need to incorporate green elements into our laws and regulations to build a comprehensive incentive and restrictive mechanism.

To materialize our green vision, we will need a well-coordinated approach among various bodies, including the central government, state governments, Finance Ministry, RBI, Ministry of Environmental Forest and Climate Change, SEBI, and even IRDAI, Insurance Regulatory, and Development Authority of India.

Together with these entities, the government needs to strengthen its institutional framework, coordinate climate finance amongst multiple stakeholders, and establish mechanisms around green finance.

India also requires an independent think tank that can conduct research in green finance to promote innovative mechanisms and bring best practices from the international markets. Examples of such organizations can induce PRC’s IIGF, the International Institute of Green Finance, which has emerged as one of the globe’s leading financial think tanks.

IIGF of the Central University of Finance and Economics specializes in green finance, energy finance, and climate finance. IIGF researches credit, insurance, bond, information disclosure, carbon trading, and risk assessment locally and nationally. It is also one of the executive member institutes of the Green Finance Committee of the China Society of Finance and Banking. It has built an academic relationship with the Finance Ministry (20).

In addition, India can also focus on:

Building a domestic framework for environmental risks (21)
Government-supported green bank (22)
Recalibration of the financial industry for green finance

Opportunities with Green Finance

Considering that the Indian capital market is still evolving, India has a huge opportunity to pioneer and expand green solutions for capital and investment raising via debt and equity.

It can include green bonds, credit enhancement schemes, aggregation and securitization, ESG investments and funds, blended finance, and infrastructure investment trusts.

Moreover, green finance is not limited to large-scale projects like solar energy, water management, etc. It can also include smaller projects like green buildings, pollution prevention, clean transportation, and energy-efficiency projects. In other words, there are also tremendous opportunities in retail banking.

Retail banks are well-positioned to support the mass adoption of green finance since they are already rooted locally and serve both individuals and businesses. As people, in general, are becoming more aware of the environmental impact of their actions, there is an opportunity for banks to fulfill their relationships, improve their market share, profit, and strengthen customer loyalty.

Banks could also improve their brand image by increasing the adoption of green practices like paperless banking and launching products that reward their customers for going green.

Correspondingly, there’s an opportunity to integrate environmental incentives in diverse green projects and their mainstream offerings like green finance for business and project loans, insurance, housing, and vehicle credit (23, 24, 25 ).

The Closing Remark

India needs solid efforts, a comprehensive approach, and a collective vision of regulators, policymakers, and stakeholders across the financial system to meet its climate goals. The way forward is to initiate a narrative around sustainable and green finance.

Since investments are all about risk and rewards, we can take this opportunity to recalibrate our risk criteria for the long-term towards climate finance. Yes, even if we need to put a risk premium on every Indian polluting asset.