Climate risk is business risk. Yet, a great deal of ESG reporting in India is perfunctory, compliance-driven, with a check-the-box approach. How should we view the role of the regulator in this context?
There is physical risk for businesses from climate change. Certainly in the West, but this is true especially in India, because it’s a very agriculture-heavy economy. We get cyclones and floods here; it’s also an area where we have, unfortunately, very bad air quality in some of the large cities.
So how do you decarbonise and grow at the same time? This is the fundamental question. If you’re an individual company, the climate will start hurting your bottomline in various ways. For example, if you’re a company that makes soda, it’s going to raise the price of sugar or beets. Some of the impact of climate risk, I think, is showing up in food inflation too, not often appreciated.
For all businesses, in the long run, climate risk is almost certainly a problem, certainly a game changer. Mitigation is expensive and transition risks, in terms of, say, moving to EVs, bring their own challenges—how do you source nickel or cobalt?
Maybe that is the role of the regulator. Companies do get worried about the next quarter, or the next year, and so on. But maybe, despite the fact that the reporting frameworks are not fantastic, this is a way for companies’ boards to think about climate afresh, think about a long-term perspective, think about how it affects costs, how it affects revenues. Maybe these are opportunities as well—it may not be only a defensive conversation.
A charitable way to think about a check-the-box approach to regulatory compliances with regard to climate could be that it pushes people to open what’s otherwise a blind spot in the boardroom, and ask, what is our climate strategy?
Let’s look at it from the point of view of common investors. Socially responsible investing is a niche but growing investment strategy. We’ve begun to track ESG funds. What is the gold standard to know if ESG funds and other socially responsible investments are really true to their principles?
Typically, if you restrict your investment opportunity set in any way, elementary finance theory tells you that your returns will either go down or your risk will go up. In this context, you’re probably trading off values for value. Maybe you do not want to support a tobacco company, which at the end of the day ends up giving people cancer. But then you’re probably giving up some returns—tobacco stocks typically have high yields, good dividends. You could say the same for oil and gas, maybe guns and weapons.
So there is no gold standard, is the answer.
You can try various things. You can look at ratings, but rating agencies have their own problems. I would say research is the only answer. It’s almost a bit like pornography. You know it when you see it, but it’s very hard to define.
You can look for a fund that doesn’t invest in tobacco, perhaps doesn’t invest in oil and gas. But again, it’s complicated. Some of the best green patents these days are with oil and gas companies. It’s incredibly hard to come up with a gold standard. So do your own due diligence. Use some of the secondary data as a starting point, but not as a definitive point.
How do you filter these issues of trust in your work?
The way we try to figure out what is good ESG or what is bad ESG, at least in my research, we look at a database called a Violation Tracker database. That database simply compiles the enforcement record for thousands of US companies across all government agencies that are supposed to take care of stakeholder interests.
So on labour, what is the company’s track record with the Occupational Safety and Health Administration (in the US)? If you’re looking at the environment, what’s your track record with the US Environmental Protection Agency?
A nonprofit has compiled this, so I can just go to their website, plug in a company’s name and see their entire rap sheet. That is verifiable data, with none of the subjectivity that rating agencies have. If you’re truly a good ESG stock, and if you’re truly taking care of your constituents’ interests, hopefully you have a very thin rap sheet as opposed to a long one with the regulator. We need something like that in every market.
India recently introduced regulations to combat greenwashing in the financial and corporate sectors. Will law suffice to influence corporate reporting practices in the context of ESG disclosures?
Greenwashing is just one more extension of society’s eternal fight in trying to police labels, because you need customer trust behind the label. It is good to have a law on the books, but implementing that is always going to be a headache. The responsible companies will do more than what is required by legislation. I did some work for a multinational and we found that if you have a green label and if you trust the green label, you can actually charge 5% to 7% more.
I am a business school professor, profits are not a bad word in our school. Somebody has to pay more for this organic brand, for the green brand, and simply to protect the profits, companies will do the right thing. If it is just going to be a charitable exercise, charity is not sustainable.
So maybe the only answer is, integrate values and value, make it part of your brand, make it part of your strategy.
