Will ESG soon become as powerful as EPS? – The Hindu BusinessLine

Clipped from: https://www.thehindubusinessline.com/todays-paper/tp-opinion/will-esg-soon-become-as-powerful-as-eps/article65235750.ece

Sustainability is no longer a choice for big companies. If ESG is not taken seriously, it will start affecting their bottomline, brand value and valuations

As climate change and sustainable development discussions are becoming more focused, the push from investors and regulators is increasing on companies to come out with their ESG (environment, social and governance) initiatives and disclosures.

Though ESG scores were not commonly part of mandatory financial reporting, SEBI’s notification in May 2021 mandated the top 1,000 listed companies to furnish a Business Responsibility and Sustainability Report (BRSR) to the stock exchanges as a part of their annual reports. Under BRSR, companies should describe the initiatives taken from an ESG angle along the nine principles. The same will be mandatory starting FY23. The proposed framework is in line with various international standards.

Institutions such as Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), International Integrated Reporting Council (IIRC), and the Task Force on Climate-related Financial Disclosures (TCFD) are working to form standards for comprehensive corporate reporting and incorporation of those factors into the investment process.

Why ESG compliance

Sustainability is no longer a choice for big companies. If not taken seriously, it will start affecting their bottomline, brand value, and valuations. Organisations ought to become conscious of the triple bottomline — people, planet, and profits. This will deliver high risk-adjusted returns over the medium to long term.

Coca-Cola factory had to be closed following local protests in Plachimada, Kerala, over depletion and toxification of groundwater. The Coca-Cola Company in 2021 announced a holistic strategy to achieve water security through 100 per cent regenerative water use — that is, reduce, reuse, recycle and replenish the water they use locally.

Rio Tinto in 2020 sacked three senior executives, including the global CEO, after intense pressure from investors over its decision to blow-up a 46,000-year-old rock shelter and a heritage site at Jukaan Gorge in Western Australia. The company stated, “We fell far short of our values as a company and breached the trust placed in us by the traditional owners of the lands on which we operate.”

In recent years, de-carbonising the economy has been a policy imperative for many governments across the world. The path and pace of this policy shift could expose conventional businesses to a range of transition risks. For instance, the EU is pushing for the world’s first carbon border tax on imported goods like carbon-intensive steel. It plans to levy the tax in a phased manner from 2026. This will directly impact India’s steel exports. Tata Steel recently said that it is developing hydrogen-based steel-making technologies to cut emissions. JSW is also in talks with GAIL India for the supply of natural gas to its biggest mill.

ESG metrics are not going to be just for compliance, rather they will decide the survival of companies themselves. There is growing research that shows that ESG issues pose a critical risk to business operations and profitability, thereby hitting the bottomline of the companies and their valuations.

Transitioning to an ESG compliant business model will have cost implications. But will that affect the financial stability of the company? No. According to PwC’s recent survey, 75 per cent of the investors thought it was worthwhile companies sacrificed short-term profitability to address ESG issues.

Strong ESG compliance correlates with higher long-term equity returns, and McKinsey validates this. Reducing business risks around a company’s ESG footprint can help reduce the likelihood of reputational damage, regulatory costs and attract better investments.

As per OECD’s recent report on ESG Investing, financial markets have started pricing in a low-carbon transition. Notably, the average return on invested capital (ROIC) of coal companies has been decreasing, reflecting the coal industry’s lower profitability and the rising cost of capital. Valuations and the cost of capital for automotive companies appear to have been impacted.

Investors have started to reward auto companies for implementing transition plans over those without transition plans.

According to Bloomberg Intelligence, ESG assets will exceed $53 trillion by 2025 representing more than a third of the $140.5 trillion in projected total assets under management. As per PwC’s 2021 Global Investor Survey, 80 per cent of those surveyed view ESG risks as a major factor in their investment evaluations.

Way forward

In the near future, it is probable that there will be more companies like the Paris-based Danone Group, which published “carbon-adjusted EPS”. The same was calculated by subtracting the theoretical value of carbon emission per share from the actual EPS (earnings per share).

With the synergistic push in investments and regulatory trends, it makes perfect sense for companies planning an IPO or investments to establish and promote their ESG strategies for investors to assess. LIC is looking to get an ESG score before its IPO.

This development is unique and important as this is perhaps the first time an Indian company has sought an ESG score before its IPO.

The writer, an IRAS, is serving in DFCCIL on Deputation as Deputy General Manager. Views are personal

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