Topic: GS2 – Governance – Government policies – Interventions for development in various sectors |
Context: |
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What is ESG?
- ESG goals are a set of standards for a company’s operations that force companies to follow better governance, ethical practices, environment-friendly measures and social responsibility.
- Environmental criteria consider how a company performs as a steward of nature.
- Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates.
- Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
- It focuses on non-financial factors as a metric for guiding investment decisions wherein increased financial returns is no longer the sole objective of investors.
- Ever since the introduction of the United Nations Principles for Responsible Investing (UNPRI) in 2006, the ESG framework has been recognised as an inextricable link of modern-day businesses.
Differing from CSR:
- India has a robust Corporate Social Responsibility (CSR) policy that mandates that corporations engage in initiatives that contribute to the welfare of society.
- This mandate was codified into law with the passage of the 2014 and 2021 amendments to the Companies Act of 2013.
- The amendments require companies in any given financial year to spend at least 2% of their net profit over the preceding three years on CSR activities.
- Whereas ESG regulations differ in process and impact.
Historical Context and Evolution:
- The concept of ESG is relatively young, having been formally introduced in a 2005 UN report titled “Who Cares Wins: Connecting Financial Markets to a Changing World.”
- This report urged financial institutions, investors, and regulators to collaborate in promoting sustainable practices.
- Today, ESG principles are deeply embedded in the global corporate landscape. According to the Global Sustainable Investment Review 2022, ESG-driven investments now represent over a third of all assets under management worldwide, underscoring the widespread adoption and importance of this framework.
The Challenges of Measuring ESG:
- The measurement of ESG performance has spawned a thriving industry with various reporting frameworks and metrics.
- However, the lack of standardization and inherent subjectivity in these evaluations often undermines their credibility.
- Reports indicate that ESG ratings from different agencies align only about half the time, highlighting the inconsistencies and challenges in achieving a unified assessment approach.
- The complexity and diversity of factors involved make the prospect of standardized ESG metrics seem distant, posing a significant hurdle for consistent and reliable evaluations.
Critical Reevaluation of ESG Practices:
- Two decades after its inception, there is growing scrutiny of the ESG framework. Questions are being raised about its effectiveness and inherent deficiencies.
- Notably, BlackRock, the world’s largest asset manager, has distanced itself from the ESG acronym, suggesting it is in a “death spiral.”
- A fundamental criticism is that ESG ratings often focus on how external risks like climate change and social upheaval affect an organization’s performance, rather than how the organization impacts the environment and society—a concept known as “single materiality.”
- Efforts to adopt “double materiality,” which considers both internal and external impacts, face significant challenges due to their complexity and reliance on uncertain assumptions.
The Paradox of Combined ESG Metrics:
- Combining the E, S, and G components into a single evaluation metric can lead to paradoxical outcomes. For example, Dow Jones Indices excluded Tesla from the S&P Sustainability Index due to workplace and governance issues while retaining Exxon Mobil, an oil giant.
- Similarly, some cigarette companies have been rated as more ethical investment destinations than Tesla, highlighting the inconsistencies and potential misalignments in the current ESG evaluation approach.
Toward a More Focused ESG Framework:
- The critique of the ESG framework suggests that it might be serving as a superficial solution, avoiding the difficult decisions needed to address critical issues like climate change and inequality.
- There is an emerging consensus that organizations should prioritize environmental concerns, particularly emissions reduction and mitigating adverse climate impacts, while separately addressing social and governance aspects.
- This separation could enhance comparability and clarity, ensuring a focused approach to the most pressing challenges.
Conclusion:
- Experts argue that ESG, “born in sanctimony, nurtured with hypocrisy, and sold with sophistry,” needs a fundamental overhaul.
- Simplifying the ESG framework to focus primarily on environmental impacts, particularly emissions reduction, could lead to more effective and measurable outcomes.
- By unbundling the ESG matrix, organizations can better align their strategies with the critical essentials necessary for our survival, addressing the urgent need for environmental sustainability while separately managing social and governance issues.
What is the Need for ESG in India? |
What are the Challenges related to ESG Compliance in India?
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Practice Question: Critically examine the effectiveness and challenges of the Environmental, Social, and Governance (ESG) framework in shaping modern business practices. Discuss whether a more focused approach on environmental sustainability, particularly emissions reduction, could enhance the impact of ESG initiatives. (250 words/15 m) |