Socially Responsible Investing in Emerging Markets

 

Each week Emerging Markets ESG publishes an interview entitled, “Five Questions about SRI.”  The interview features a practitioner’s insights about SRI in emerging markets and through Emerging Markets ESG shares this expertise with a wide global audience. On March 08 2013, Emerging Markets ESG published the interview with Shriram Subramanian, Founder and Managing Director, InGovern Research Services, Bangalore, India and his insights about SRI in emerging markets, the extract of which is given below:

 

How would you define socially responsible investment (SRI)?

Socially Responsible Investing (SRI) is an investment process that considers the social and environmental consequences of investments, both positive and negative, within the context of rigorous financial analysis and involves the incorporation of these factors into investment management. SRI basically takes into account monetary returns, social benefits and environmental sustainability factors and invests in businesses which demonstrate a high level of commitment to meeting these environmental, social and governance (ESG) standards. Issues such as climate risk management, social and environmental risk management, undertaking activities that lead to natural resource depletion, human rights violations, labor standards, anti-bias employment policies, corporate social responsibility themes, improved shareholder proxy access, executive compensation, board diversity and independence, etc. are some of the factors on which most companies might fail the ESG evaluation criteria. In the Indian context, where growth and employment creation is pursued, SRI practices are limited. The latest Companies Bill mandates that every large company spend 2% of net profits on corporate social responsibility activities.

 

What distinguishes SRI from mainstream investment?

Mainstream investments have largely been focused only on financial returns on their investments without any consideration of the ESG factors affecting that investment. Investment managers and market participants under the mainstream investing analyze financial performance of the companies or assets they invest in with the sole purpose of generating financial returns but largely ignoring ESG impact factors due to those investments. In contrast, SRI is any investment strategy which seeks to consider both financial return and social good. SRI avoids investing in companies which do not demonstrate a high level of commitment to meeting ESG standards.

 

Which extra-financial theme – environmental, social or governance – is the most challenging for investors in Indian companies to analyze?

The most critical aspect of SRI is the development of non-financial metrics relating to ESG factors which can be used for evaluation, screening and analysis of socially responsible investments. While corporate governance factors such as compliance with local regulations, upholding minority rights, executive compensation, board diversity and independence are comparatively easier to report, track and evaluate, more development is needed of reporting and analyzing factors relating to social and environmental risk management, climate impact, corporate social responsibility themes, labor standards, etc. Data on environmental and social themes is not readily available from companies in India. Thus a need arises for a standardized reporting framework by Indian companies. UN Global Compact, Global Reporting Initiative (GRI) and Carbon Disclosure Project are internationally accepted reporting frameworks which provide a platform for companies to disclose their sustainability practices and policies. In India, the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business of 2011 is a step in this direction in the Indian context. Only one Indian financial institution – IDFC – is a signatory to the UN Principles for Responsible Investment (PRI), while over 270 Indian companies and institutions are signatories to UN Global Compact.

 

Which extra-financial theme – environmental, social or governance – is the most challenging for companies in India to manage?

All three non-financial metrics are equally important and Indian companies should put in place systems and process to manage risks arising from any of these factors. The first step towards managing these risks is for companies to adopt sustainability reporting and mainstream disclosures on environmental, social and governance metrics. A continuous monitoring and evaluation of these metrics can help in effectively managing these risks. While corporate governance factors are more frequently reported by companies, social and environmental reporting are often ignored by even investor friendly companies and hence evaluating and mitigating these risks become that much more of a challenge. Even factors such as issues related to land acquisition, resource allocation policies of government; law enforcement, etc. play a huge role in managing these risks. InGovern as a pioneer proxy advisory firm digs deep into corporate governance issues of listed and unlisted companies. Institutional investors commission InGovern to analyze and monitor their investments for governance related issues.

 

How has the Satyam scandal impacted the regulatory environment for ESG reporting in India?

The Satyam scandal was a watershed event which led investors and regulators in India to realize the importance of ESG reporting. Immediately following the Satyam scandal in 2008, the Corporate Governance Voluntary Guidelines 2009 was announced by the Ministry of Corporate Affairs. Such awareness has led to substantial improvements both in the Indian regulatory framework as well as investor scrutiny of portfolio companies on many parameters. Substantial changes have been incorporated in the Companies Act for minority investor protection. The Securities and Exchange Board of India (SEBI) has also incorporated many changes in corporate governance reporting and mandatory disclosure requirements on listed companies. Further, SEBI’s recent proposal to improve the corporate governance framework by amending the listing agreement provisions as well incorporating new mandatory provisions for Indian companies to comply with are some of the steps in this direction. However, most companies in India have not yet adopted ESG standards that are basic, essential and may even be a part of many a company’s corporate responsibility. There is an imminent need for improving compliance, disclosures and reporting framework for companies on the ESG front. Much of the ESG reporting has to move from being voluntary to mandatory. There is also a need for investors and market participants to move on from relying only on normal channels of information such as company reporting to capturing other relevant submerged information about their portfolio companies.

 

The full article can also be read on this link: Emerging Markets ESG – March 08 2013