Will Net Zero Transition Pathway be Built on the Foundation of ESG?
Manu Maudgal, December 14, 2022
Recently, I had the opportunity to attend conclaves of seemingly diverse communities—investors focussed on impact and corporates focussed on deploying philanthropic capital on Corporate Social Responsibility. I was therefore surprised by the common focus of both modern-day investors and philanthropists on—Environment, Social and Governance (ESG) based investing and programmatic interventions respectively. This set me thinking on what is unique to ESG that converges interests of such diverse stakeholders.
Today, it is unambiguously accepted that business activity solely driven by short term profit to increase shareholder value alone is not sufficient and can adversely affect our environment and our societies. Modern thinking on ESG is borne out of the historical focus on social aspects of a business and the debate over ‘limits to growth’.
For the un-initiated, ESG stands for:
- Environmental criteria, such as waste, energy and resources an entity needs and resultant consequences on living beings.
- Social criteria such as the relationships and reputation the entity enjoys with people and institutions in the communities where they conduct business.
- Governance, which is the amalgamation of the internal system of practices, controls, and procedures the entity adopts to govern itself—makes decisions, complies with the law, and meets the needs of external stakeholders.
While ESG based capital deployed is touted to be the panacea to reduce costs, mitigate long term business risks and enhance reputations, opinion remains divided. Practically speaking, a stakeholder investing in ESG is not actually investing based on ESG but on the interpretation of a rating agency they have chosen. There are problems associated with this approach.
Research reveals near 80 per cent correlation between the ratings of different agencies for credit ratings, this correlation is just 30 per cent for ESG ratings. This means that on average, ESG rating agencies disagree on the rating70 times out of 100! This results in the question—how are stakeholders supposed to invest in ESG initiatives when there is limited agreement on what constitutes ESG behaviour?
Now that India has declared the Net Zero Goal for the year 2070, the declaration shifts the climate action narrative from an add-on to a must do, heralding a new paradigm wherein climate action is equivalent to economic development. These investments would be front-loaded. A recent estimate projected a spending rise to almost 9 per cent of GDP between 2026 and 2030 from about 7 per cent before falling. [Mckinsey Net Zero analysis 2022].
While these spending requirements are large and financing is yet to be established, and benefits will accrue over the longer run, potential short- or medium-term socio-economic risks that could impair the transition itself need more detailed study. Expecting individuals to champion sustainable behaviour is certainly not the solution. The main responsibility for pushing a new development paradigm necessarily lies with the government and companies.
This is how the renewed emphasis by various stakeholders on ESG must be viewed. While investing to improve the world is a laudable goal, investing without concomitant eco-system mobilisation will neither be advantageous for investors nor for society. Depending on stakeholder perspectives, applying an ESG lens can help kick-start and support multiple value streams to support key development priorities. An ESG lens can build information through extensive field inquiry, secondary research, multiple conversations and dialogues with stakeholders, thought leaders and domain experts to yield:
- Technical assistance for decision support–Data and research study
- Market Advisory assistance–Identify and solve last mile gaps
- Assess via standardised monitoring, evaluation and learning
- Periodic opinion building pieces through media
- Thematic convenings
- Innovation to industry–Enable technology and ecosystem evolution
- Technology demonstration and business model validation
As a crucial world economy, India is venturing into its unfinished developmental agenda by relying on non-fossil energy sources. As India embarks to balance growth with sustainable development, it must be recognised that the developmental plan undertaken by India has no historical precedent or ready lessons that can be drawn from developed countries. India must carve out its own niche, become a harbinger of the new economic growth. The country’s victories and triumphs will lead the way for the developing world to pioneer pathways for sustainable economic progress, where an enhanced focus on ESG led actions will prove propitious.