As environmental, social and governance (ESG) consideraons exploded into the business mainstream over the past few years, climate change has dominated the ESG conversaon (with efforts to limit global warming to 1.5 degrees Celsius sll racing against me) India Inc. has been responsive to this urgency for some me now - several Indian businesses have voluntarily commied to reducing their carbon footprint and emissions. When it comes to ESG corporate performance, the expectaons of key business stakeholders such as investors, regulators, customers, and employees are increasing. ESG consideraons are increasingly influencing the deployment of investment capital, and there is a tremendous appete for ESG financial products. This has led to an increase in awareness in both the companies that are looking for investment as well as intermediaries such as rang agencies. The regulators are acvely incorporang ESG and sustainability factors into the legal framework in ways that will change how companies operate. In tandem with these regulatory drivers, investors are very much cognizant that corporate cizenship embraces businesses' social, environmental, and cultural responsibilies towards their employees, workforce, customers, and society. This is being signaled not just by preferring to put capital where it is ulised sustainably, but also through increased investor engagement on non-financial parameters such as workplace culture and conduct, resource efficiency, human rights violaons in the supply chain, ethics, governance and corrupon, product safety, and reputaonal risks. All this has led to a complete change in the narrave around ESG in India. The queson that markets are asking is not `if' but `how'. The answer perhaps is, by way of `intent'- with companies stepping up to the call for corporate responsibility, investors leading the mission with stewardship and government enabling policies that facilitate the transion. FICCI has been at the forefront of facilitang this dialogue, and connues to engage industry parcipants and regulators in several acvies over the course of the year. FICCI's maiden ESG Summit is a surefooted step towards this endeavour. FICCI and Trilegal are pleased to present to you this publicaon, ESG Into the Mainstream, which presents thoughts and narrave on the key themes that the Indian industry will face in its ESG journey. While much work remains in furthering the ESG agenda, including in the areas addressed by this paper; it is encouraging to note that the trend has been in the right direcon, and that changes that have been implemented in recent mes will drive improvements in financing India's sustainability agenda.
Arun Chawla
Director General FICCI
Upasana Rao
Partner TRILEGAL
Kunal Gupta
Partner TRILEGAL
Contents
CHAPTER 01 Unlocking Green Finance Policy intervenons Disclosure and transparency Sources of finance Green Bonds Developing an internal carbon market Blended Finance Corporates and retail investors
CHAPTER 02 Redefining Corporate Cizenship - the road to sustainability Corporate Governance Corporate Social Responsibility Contribung to the sustainability agenda
CHAPTER 03 ESG Crisis Readiness and Response: A Toolkit Legal and Regulatory Developments Impacng Businesses in India Best pracces for pre-empng and handling ESG crises
CHAPTER 04 Regulaon of ESG Rangs Providers In India Thoughts on the Proposed Regulatory Framework
GUEST CONTRIBUTION Fundamental power sector reform needed to incenvise climate finance Power sector reforms will go a long way towards encouraging ESG-led investment
01
05 08 13 16
1. Unlocking Green Finance
India has recently stepped up its climate acon goals significantly beyond its previously set Naonally Determined Contribuon (NDC) targets, commied to reach a non-fossil energy capacity of 500 GW and reduce the carbon intensity of its economy to less than 45 percent by the year 2030, and a Net Zero emissions target for the year 2070. At the same me India has also acknowledged that nearly $1 trillion needs to be mobilised as green finance towards achieving these goals. India is a country of 1.3 billion people and the third largest emier of greenhouse gases in the world, yet a growing economy with sll expanding needs for infrastructure development. To achieve its climate targets and fund its green transion, India needs a large budget allocaon, internaonal finance from bilateral and mullateral sources and green private investments. India needs to improve its readiness to access and deliver climate finance from all available sources. This involves different aspects: Polical and strategic readiness with a naonal green policy, planning and resource allocaon, Creang invesble projects, adopng measurement and disclosure standards, and Legal readiness to provide a framework that enables innovave financing structures and de-risking
investment opportunies. Policy intervenons Over the last decade, India's policy efforts have achieved significant renewable energy deployment. India already generates 20% of its power requirements from renewable sources. Producing renewable energy has become more cost efficient and supply is available at compeve pricing. The recently introduced producon linked incenve (PLI) scheme for solar panels will reduce dependence on imported components and allow supply chains to be more resilient. India also announced the ambious `One Sun, One World, One Grid' (OSOWOG) programme with the Green Grids Iniave (GGI) of the UK, which entails connecng clean energy grids across connents. This is an opportunity for India to parcipate across the global renewable energy value chain. Incorporang net-zero targets into overall domesc policy and sector-based intervenons, will provide regulatory clarity to investors to finance India's plans for decarbonizaon and net-zero pathways to development. For example, transion to green mobility is quickly picking up with policy intervenon and market response. The Faster Adopon and Manufacturing of Hybrid and Electric Vehicles scheme (FAME) and a Producon Linked Incenve (PLI) scheme incenvises EV manufacturers and charging infrastructure providers, and different state governments have implemented their own EV policies and subsidies to promote e-mobility. Another challenging policy issue is of carbon taxaon. Currently India has a coal cess penalising the use of coal and excise duty on petroleum products, and certain states have implemented green taxes within their territories. India could introduce a uniform carbon tax policy which would incenvise Indian companies to prefer alternave energy sources.
01
Disclosure and transparency One of the barriers that India faces in accessing green finance, is the lack of a green taxonomy. Regulators in India have acknowledged that reporng asymmetry and the lack of a standardised global taxonomy are the key reasons for the relavely high cost of green bonds which have seen low interest from investors. A green taxonomy would provide clarity on what acvies qualify as `green' and establish the eligibility criteria for green finance. Adopng such a taxonomy would reduce the chances of greenwashing and enhance investor confidence. A green taxonomy will also lead to aenon towards sectors in need for investment taking away the sole focus from renewables which tends to garner the most aenon in India. Addionally, it will ensure that regulators such as Securies and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) align their regulaons with the taxonomy. While developing this taxonomy, policy makers could look at the green financing definions as provided by Sustainable Banking Network (SBN); Principles for Responsible Invesng (PRI); Carbon Disclosure Project (CDP); Sustainable Accounng Standards Board (SASB); OECD and UNFCC. India's environmental laws specify environmental impact assessment protocols, polluon standards, compliance and disclosure requirements for industries. However, the current environmental legal landscape is insufficient and needs to be augmented to bring in a strong climate transion plan which industries can follow, and regulators can use to regulate. Naonal environmental regulaons may also need to be strengthened to align with standardisaon norms under a new taxonomy. The standards for disclosure and sustainability reporng are sll at a nascent stage in India. In May 2021, SEBI issued a sustainability disclosure norm, `Business Responsibility and Sustainability Reporting (BRSR) by listed companies', which mandates the reporng of ESG performance by top listed 1000 companies with the largest capitalizaon. Over me the sustainability standards under BRSR may be made mandatory for all companies which will allow companies to be transparent with investors about their ESG pracces. Banks, insurers, asset managers, pension funds and global investors need to rely on data and metrics to make informed decisions on capital allocaon and risk underwring. In the Indian context, investors have had to rely on voluntary disclosures by companies, which are oen incomplete, inconsistent, and subjecve. The Bombay Stock Exchange offers a benchmark index, which assesses the `carbon performance' of stocks based on quantave performance parameters. This is a step in creang an inclusive market-based mechanism to promote energy efficient pracces amongst issuers and aract green finance. However, India needs regulatory standardisaon of climate disclosure and reporng, to enhance its credibility and negoate for green finance. Mandatory reporng standards, data and measurement will help to channelise instuonal green investments to India.
02
Sources of finance Raising green finance requires access to diverse sources of capital, public and private sector parcipaon and appropriate financing structures. There is a need diversify financial assets and enable mobilizaon of private capital for sustainable development in India. a) Green Bonds In 2017, SEBI enabled raising capital through the issue of green bonds by Indian companies and mandated related disclosure norms broadly based on the Green Bond Principles framed by the Internaonal Capital Markets Associaon in 2014. Green bonds can be issued only for assets or projects with an environmental purpose such as renewable energy, clean transport, sustainable water or waste management, energy efficiency and climate change adaptaon, and funds raised need to be ulised enrely for the same purpose. The eligibility criteria is clearly demarcated and many companies may not be eligible to issue green bonds to support their clean energy transion if they have long investment cycles in carbon assets. The uptake of green bonds has been slow largely due to the lack of a green taxonomy and an assessment and rang framework. Green bonds can be scaled up if the domesc bond market is made stronger, the exisng regulaons are made more inclusive, the use of proceeds criteria is broadened. Credit enhancement methods through the creaon of guarantee funds, issuing of sovereign green bonds, hedging support, and extending tax incenves to such bonds will further support the use of this instrument. As of now Indian banks have only voluntary guidelines for responsible financing proposed by the Indian Banks Associaon, under which it is recommended that ESG factors be integrated into the investment, lending, and risk-management processes of banks. Preferring green investments in central bank operaons, relaxing prudenal requirements for investment in green sectors, and including other green labels within priority sector lending (which is currently focused only on renewables) will unlock high amounts of domesc capital from Indian banks. The Indian government announced the issue of sovereign green bonds in the years budget session which would be a useful tool to raise capital at reduced cost of capital for diverse green projects in different sectors, and further catalyse the deepening of India's green finance market. India's Internaonal Financial Services Centre (GIFT City) would also provide a suitable framework to channelize foreign capital for sustainable financing as it provides a plaorm within India where foreign currency can be accessed with low tax impact, trading exchanges are available for all asset classes, and innovave financial products and structures for debt financing can be explored with regulatory support and transparency. To encourage more foreign debt financing for green projects, it may be recommended to provide relaxaons under the regulaons applicable to external commercial borrowings and issuing of debt securies to foreign porolio investors, such as relaxaons from various restricons of maturity period, use of proceeds, pricing caps, withholding taxes, concentraon and single issuer limits in cases where the debt is being raised is for green projects.
03
b) Developing an internal carbon market One of the key outcomes of the COP26 conference in November 2021 was the conclusion of the Paris rulebook which included the agreement of the fundamental norms which will govern carbon trading. This development will give a push to develop a domesc carbon market for emission trading in India. Currently India does not have an explicit mechanism for carbon pricing or market-based carbon trading. A voluntary carbon market for the private sector may be developed by defining a mechanism for idenfying quality carbon offsets, developing carbon accounng standards and a transparent pricing mechanism. c) Blended Finance Accessing finance for small scale and micro impact projects requires moving away from tradional public grants, instuonal lending and philanthropic sources, and explore blended finance structures that allow strategic use of development finance from private investors for sustainable development. Social impact bonds for climate transion can be used as a funding structure for small budget intervenons at the district, municipal and state levels, which blends impact invesng, public-private partnerships and outcome-based finance. Outcome based funding structures enable investors to provide upfront early risk financing to implement green projects. There is a need to incenvise more investors willing to provide such "first loss capital" to de-risk projects and catalyse further investments. Such incenves may be provided by offering more viable/invesble projects where the outcome parameters are clearly defined, providing guarantee support to back stop unknown risks and providing regulatory relaxaons to facilitate flexible funding structures. d) Corporates and retail investors Corporate funds can be a useful source for green finance. Indian company law mandates profit making corporates to allocate funds towards corporate social responsibility (CSR) acvies which are unrelated to their own business. Many corporates choose to fund environmental causes as part of their CSR strategy, for example, afforestaon or developing solar parks. There is potenal for more concerted ulisaon of CSR funds towards climate and greater impact can be achieved by creang CSR fund pooling vehicles which specifically target climate migaon measures. However, certain compliance requirements under the CSR rules, parcularly the requirement to transfer `unspent' CSR funds to specified government relief funds, could be inconsistent with the needs of climate projects which have longer gestaon periods. SEBI also recently launched the Social Stock exchange in India which provides social enterprises and social venture funds an alternate plaorm to raise funds from instuonal and retail investors and aract CSR funding with transparency. Clarificaons will be required under the Foreign Contribuon (Regulaons) Act to enable foreign investors to invest in social venture funds listed on the social stock exchange.
04
2. Redefining Corporate Citizenship the road to sustainability
The noon of corporate `cizenship' is that corporaons as members of society, carry obligaons beyond their financial acvies, to contribute posively to the community and environment. This construct is broader than the known ideals of corporate governance in which primacy is given to protecng the interests of the shareholders and maximising the economic value of a company. In a world engulfed with the pandemic, global warming and high levels of inequality, the pressure is rising on companies to embrace ESG (environment, sustainability, and governance) principles more holiscally. The law and regulaons in India are slowly adapng to this new reality. Corporate Governance Corporate governance, the pracces by which the board and management of a corporaon direct, control and oversee its affairs, has implicaons not only to the shareholders but also to the employees, lenders, vendors, customers, and other stakeholders, including the communies in which the business operates. The scope of corporate governance regulaons has evolved connuously. The tradional aspects included the role and conduct of directors, transparency and accountability, conflict of interest and investor relaonship. Regulators, investors, and acvist shareholders now increasingly expect boardrooms to focus on a wider array of issues such as gender diversity, risk management, succession planning and relaonship with `all stakeholders' of the business. The Companies Act, 2013 codified the fiduciary dues of directors for the first me, including the duty to act in good faith and promote the objects of the company in the interests of the employees, shareholders, community, and the environment. The Kotak Commiee Report1 noted that the board of director's strategy and evaluaon of ESG maers is crical to the long-term future of the company and recommended that the board's obligaon to redress shareholder grievances be broadened to include the responsibility to consider the `various aspects of interests' of the shareholders and other stakeholders. Courts in India have acknowledged that companies are not a mere legal device for carrying on trade, rather, they wield economic power that can affect society and the environment. In recent cases, the courts have recognised that the corporate world is moving to a regime of social accountability and have also quesoned why companies cannot mobilise financial resources to align their commercial acvies with corporate social responsibility. Good corporate governance enables companies to aract capital and win investor confidence. Evidently, many investors have started to measure business performance in new ways, with greater aenon to non-financial metrics and management of ESG risks. The meaning of long-term value creaon is also changing in the expectaon of investors. It is not only concerned with profit-making and the top line, rather a value system that includes employee engagement, environment sustainability, diversity and inclusion, risk management, cybersecurity and broader societal imperaves. The pandemic exposed the need to manage ESG risks in the enre supply chain to avoid business instability.
1 Kotak Commiee Report on Corporate Governance, dated 5 October 2017
05
Recent regulaons introduced mandatory reporng requirements to help measure the performance of companies on ESG parameters. The Securies and Exchange Board of India (SEBI), the regulator for securies and commodity market in India, made `Business Responsibility and Sustainability Reporng (BRSR)' mandatory with effect from 1 April 2022 for the top 1000 public listed companies in India by market capitalizaon. The BRSR includes quanfiable metrics as opposed to relying solely on qualitave standards. This will make the ESG pracces of companies more transparent and require disclosure of maers concerning labour welfare, health and safety, human rights violaons, conflict of interest of directors and key managerial personnel and other ESG relevant issues. Other than the mandatory disclosures, the BRSR includes a category for voluntary disclosures, such as disclosing the company's strategy and sustainability iniaves to demonstrate its leadership. Over me these mandatory reporng regulaons are expected to be extended to private companies and demonstrang ESG compliance will become a legal imperave. Corporate Social Responsibility Indian company law requires profitable companies to spend 2% of their profits annually on corporate social responsibility (CSR) acvies. CSR acvies are defined to include the promoon of educaon, health, poverty reducon, environmental sustainability, and gender equality. In the spirit of corporate philanthropy, CSR cannot include acvies from which the company or its employees may themselves benefit. Pursuant to the Companies (Corporate Social Responsibility Policy) Amendment Rules 2021 nofied in January 2021, it is mandatory for companies with an annual CSR budget of Rs.10 crores or more to undertake impact assessments of their CSR projects through independent agencies. The revised law underscores that CSR is not merely a spending obligaon. Companies are being encouraged to spend CSR funds with the objecve of creang impact and to evaluate the impact of their CSR iniaves on the target beneficiaries or society. There is immense potenal for companies to ulise the CSR model to parcipate more directly in creang a posive impact. For instance, corporates can collaborate with public authories and investors to parcipate in impact projects with measured outcomes, and philanthropic CSR funds could be useful in innovave financing structures or for risk funding in blended finance projects. Contribung to the sustainability agenda Investors and asset managers have already integrated ESG factors in their mandates, but the approach is currently focused on target seng and compliance reporng. Many investors are keen to move beyond ESG invesng into the next froner of SDG invesng or responsible invesng which envisages invesng in sustainability driven projects with intenonality and measuring the impact. Progressive forward-looking companies are exploring ways to create posive impact by adopng one or more of the 2030 Sustainable Development Goals (SDGs) which have been set by the United Naons and adopted by all countries including India as the universal development agenda for this decade. These goals include a wide range of concerns, from poverty alleviaon, educaon, gender equality, clean water and sanitaon to clean energy, sustainable consumpon and climate acon. Governments across the world have pledged to reduce carbon emissions and combat climate change. At the much-observed 2021 United Naons Climate Change Conference (COP26), India announced significantly increased Naonally Determined Contribuons (NDCs) for decarbonisaon and the year 2070 as its target for achieving net zero emissions. The roadmap to achieving these sustainability goals will require massive parcipaon and capital from corporates and investors.
06
The top-down policies and commitments from the Government will create pressure on Indian companies to look beyond business as usual. Government policies may lead to new regulaons, taxes, and incenves to steer companies towards sustainable pracces. Investors may soon see the lack of a sustainability transion plan as a red flag. Climate reporng and climate accountability on the board of directors of companies have become mandatory in many countries as a response to demand from lenders, investors and other key stakeholders, and India may introduce similar compliance requirements in the future. Global consumers are looking at corporate sustainability reports and placing their choices with companies and brands who demonstrate environmental and social conscienousness. It is common now to see employee retenon and customer engagement also involve consideraon of ESG aspects, such as diversity and inclusion and sustainability commitments by companies. It has become a business imperave for corporates to include ESG performance and sustainability consideraons in their long-term corporate strategy. While many corporaons are planning their transion as an imperave to stay relevant in business, many others recognise the new market opportunies and are rushing to cater to the demands for cleaner technology and sustainable products in sectors like energy, e-mobility, agriculture, and others. Investors and asset managers have already integrated ESG factors in their mandates, but the approach is currently focused on target seng and compliance reporng. Many investors are keen to move beyond ESG invesng into the next froner of `SDG invesng' or `responsible invesng' which envisages invesng in sustainability driven projects with intenonality and measuring the impact. Conclusion It is within the above context that a new vision for corporate cizenship has emerged. Corporates will increasingly need to demonstrate ESG maturity to migate any harm caused by their business on the environment and society, and adapt posive responsible and sustainable pracces to maintain the legimacy of the business amongst stakeholders, and show corporate leadership to support India's transion to a sustainable future.
07
3. ESG Crisis Readiness and Response: A Toolkit
A. Legal and Regulatory Developments Impacng Businesses in India The framework governing ESG disclosures for Indian companies and for foreign companies operang in India is developing rapidly. Previously, only somewhat limited ESG disclosures were required for instance, certain reporng requirements on energy conservaon under company law, and other, (comparavely) detailed disclosures under the Securies and Exchange Board of India's ("SEBI") Business Responsibility Reporng framework, 2015 ("BRR") for listed companies. The successor to the BRR the Business Responsibility and Sustainability Reporng framework ("BRSR")- comes into force in April 2022. BRSR extensively builds upon BRR, by mandang more granular disclosures in areas covered under BRR (such as certain types of human rights issues), but also requiring disclosures in areas the BRR did not deal with (such as correcve acon taken post ESG complaints). Praccally, enhanced disclosures usually lead to greater scruny of the maer from shareholders, investors, and regulators, and increased awareness of issues also engenders more whistleblower complaints. Consequently, we expect an increase in companies facing ESG crises, which will have significant impact on the company from a reputaonal and financial perspecve. The manner in which emergent ESG concerns are dealt with also define how mature the ESG framework in a company is. In this chapter, we set out the changing framework of ESG regulaons and then discuss strategies to pre-empt and response to ESG crises. 1. New norms in Business Responsibility and Sustainability Reporng for listed companies The BRSR much-enhanced comes into effect for the top 1000 listed enes by market capitalizaon in April 2022. SEBI has said that the very idea behind mandang quantave and standardized disclosures on ESG is to facilitate comparability across companies, sectors, and me, which will help investors make beer investment decisions. These disclosures are also intended to propel companies to engage more meaningfully with their stakeholders, by encouraging them to look beyond financial parameters and consider their social and environmental impact. Certain new features in the BRSR will significantly prompt listed companies to look into and remedy complaints and grievances under each of the nine principles under the Naonal Guidelines on Responsible Business Conduct (Principles)2 . Thus, this entails dealing with a wide range of issues (and not just those which have a direct or foreseeable financial impact).
2 The nine principles are: Businesses should conduct and govern themselves with integrity, and in a manner that is ethical, transparent, and accountable. Businesses should provide goods and services in a manner that is sustainable and safe. Businesses should respect and promote the well-being of all employees, including those in their value chains. Businesses should respect the interests of and be responsive to all its stakeholders. Businesses should respect and promote human rights. Businesses should respect and make efforts to protect and restore the environment. Businesses, when engaging in influencing public and regulatory policy, should do so in a manner that is responsible and transparent. Businesses should promote inclusive growth and equitable development. Businesses should engage with and provide value to their consumers in a responsible manner.
08
Disclosures of ESG Complaints: BRR v BRSR
Under the BRR, listed companies were required to disclose the number of complaints received and pending (at the end of the financial year) regarding: Child labour Forced labour Involuntary labour Sexual harassment Discriminatory employment Stakeholder complaints on human rights issues Customer complaints/consumer cases
Under the BRSR, in-scope listed companies must disclose the number of complaints filed and pending resoluon at year end, as well as remarks, corresponding to each of the Principles. The number of complaints received must be broken down according to the stakeholder from whom it is received: Communies Investors (other than shareholders) Shareholders Employees and workers Customers Value Chain Partners Others
Disclosures of ESG Correcve Acon: BRR v BRSR
Under the BRR, listed companies were only required to disclose the numbers of complaints (for the topics discussed above) that were received and were pending at the end of the financial year. Details of correcve acon taken in response to complaints were not required to be disclosed.
Under the BRSR, covered listed companies must mandatorily disclose details of correcve acon taken or underway on: Fines, penales, or acons taken by regulators,
law enforcement agencies, judicial instuons on cases of corrupon and conflicts of interest (by the enty and certain categories of its personnel) Safety-related incidents or significant risks or concerns arising from assessments of (a) health & safety pracces and (b) working condions Significant risks or concerns arising from assessments of child labour, forced/involuntary labour, sexual harassment, discriminaon at the workplace, wages, and other human rights related issues An-compeve conduct Adversing, and delivery of essenal services Cyber security and data privacy of customers Repeat product recall Regulatory acon on safety of products and services
Takeaway While it remains to be seen how SEBI and investors will interpret and respond to the enhanced ESG disclosures in the BRSR, the new framework will significantly prompt listed companies to look into and redress complaints received in the above areas.
09
2. Overseas due diligence laws impacng Indian suppliers and businesses A spate of laws mandang human rights and environmental due diligence in supply chains have been passed in key jurisdicons such as Germany, France, etc. We break down below the key features of certain laws, including how they may become relevant for Indian businesses. Internaonal ESG Diligence Laws Impacng Indian Businesses
GERMANY
FRANCE
NETHERLANDS
NORWAY
Law: the Act on Corpo- Law: Law on the Corpo- Law: Child Labour Due rate Due Diligence Obli- rate Duty of Vigilance, Diligence Act, 2019 gaons in Supply Chains, 2017 2021
Law: the Transparency Act, 2021
Effecve w.e.f 1 January In force 2023 (in a phased manner)
Effecve w.e.f mid-2022 Not in force yet
Applicability: Inially, Applicability:
Large Applicability: all naon-
companies with >3,000 French
companies ally-registered mulna-
employees with head (meeng certain thresh- onal enterprises and
office, registered office olds for number of foreign companies that
or domesc branch in employees and locaon sell or supply goods or
Germany
of head offices)
services to Dutch
consumers more than
twice in a calendar year
Applicability: Companies above certain financial thresholds headquartered or with physical presence in Norway and offering goods and services in and outside Norway; and larger
foreign companies selling goods and services in Norway
Relevance for Indian Relevance for Indian Relevance for Indian
businesses: In-scope businesses: in-scope businesses: In-scope
companies
must French companies must companies must ascer-
conduct human rights idenfy and prevent tain if producon in
and environmental due adverse human rights their supply chain
diligence on inter alia and
environmental involves child labour.
the acvies of their impact resulng from The law will thus have
direct/first-er contrac- acvies of subcontrac- praccal implicaons on
tual partners, and to the tors and suppliers with Dutch sourcing from
rest of the supply chain whom they have an India, and Indian compa-
in cases of "substanat- established commercial nies selling goods and
ed knowledge" regard- relaonship
services to Dutch
ing potenal violaons
end-users.
of dues of sub-suppli-
ers.
Relevance for Indian
businesses: In-scope
companies
must
conduct due diligence
regarding human rights.
Such diligence should
cover the enre supply
chain and business partners. Given this, the law will have praccal implicaons for sourcing from India, and Indian companies doing business in Norway and meeng the requisite financial threshold.
10
Takeaway While many Indian businesses will not be directly governed by these laws, we expect to see more due diligence and audit exercises and related contractual protecons as companies directly subject to these laws step up their compliance measures. B. Best pracces for pre-empng and handling ESG crises 1. Pre-empve tools a. Map the supply chain of key goods and commodies to conduct a risk assessment for ESG risks
posed by suppliers b. Once mapped, conduct a risk assessment to idenfy suppliers who may be in industries or
geographies that are vulnerable to specific types of environmental and human rights risks For example: palm oil as an ingredient may involve deforestaon in its supply chain silica as a component may involve forced or involuntary labour in its supply chain c. Evaluate contracts with suppliers for the existence of robust clauses on the following: i. Prohibing: forced and child labour, sexual harassment and other discriminatory pracces at
factory sits, the use of conflict minerals, unethical pracces, etc; ii. Ensuring: compliance with laws on human rights, environment, labour and employment,
especially wages and working hours, an-bribery etc., as well as compliance with the company's policies and standards for its suppliers; iii. Including: rights of inspecon and audit for the company, as well as an obligaon of coopera on for the supplier; iv. Such clauses may be modified depending upon the risk level assigned to each supplier in the risk assessment exercise. d. Frame a well-defined code of conduct, including terms on subcontracng, for the company's suppliers and other third pares e. Conduct regular training for suppliers on their obligaons under the company's policies; for factory workers on their rights; and train on-site factory representaves to detect hidden signs of worker abuse by third pares supplying contract labour f. Conduct (as needed depending upon the risk level assigned) background checks on suppliers prior to engaging them, surprise site visits to contract manufacturing locaons, gather discreet informaon gathering by speaking to on-ground workers and community representaves 2. Handling ESG crises In the event concerns regarding ESG harms are raised, mulple factors, including the aspects discussed above as well as changed expectaons of corporate responsibility demand that such concerns be invesgated. Below are some aspects that should be kept in mind while undertaking such exercises in India:
11
a. In case, the ESG concerns alleged are at the level of a supplier (and not within the company): i. site visits and interviews may be necessary to make breakthroughs on verifying the allegaons. When buyer audits and inspecons are not spulated in the contract (as frequently happens, especially for third pares who work on a purchase order basis), business partners may resist such audits/inspecons on grounds of confidenality concerns, especially if they also provide idencal services for other clients. In such cases, non-disclosure agreements are customarily relied on. ii. in relaon to site visits and interviews, the contract with the business partner should be assessed to check whether there are any requirements to give reasonable noce. iii. there is no obligaon under Indian law to terminate or pause the performance of services by the supplier pending the ESG invesgaon.
b. In case, the ESG concerns alleged are within the company: i. The fact-finding exercise may need to mine several sources of data, both within and outside the company. For instance, for issues of labour and wage violaon, crical data is maintained at the factory level rather than on head office servers, as these may be manually entered in factory records and recorded in vernacular languages. ii. Collang data from sources external to the company, such as records of contractors and subcontractors, indirect suppliers, interviews with suppliers' workers, and local government registries may also be required. When interviews with workers not on the company's payroll are necessitated, these should be handled sensively in order to minimise risks of retaliaon against interviewed workers.
12
4. Regulation of ESG Ratings Providers in India
Background A crical aspect of being able to take ESG compliance to market and posion it as value accreve for businesses, is having easily available and standardized metrics to assess the compliance by industries with environmental, social and governance factors. Large companies, globally and domescally, are being evaluated by their investors and the market alike from an ESG standpoint along with an assessment of their corporate governance profiles, i.e., the company's resilience to ESG related risks, and the posive or negave impact of companies on the environment. Many instuonal investors have become signatories to global principles on responsible invesng and are striving to align their investment decisions basis these principles, which include goals such as zero carbon emission, gender diversity, etc. Proposed Regulatory Framework in India While the focus on ESG is relavely nascent, mulple players have emerged in this arena. These include instuonal investors such as mutual funds and alternave investment funds, proxy advisors as well as ESG rang providers (ERPs). In the past couple of years, regulatory authories in India have introduced requirements for certain listed companies to submit business responsibility and sustainability reports with an emphasis on ESG specific factors, and recommended stewardship obligaons for instuonal investors and mutual funds to acvely engage with investee companies on ESG parameters. While responsibilies have been cast upon listed companies and investors, there has been an evident regulatory gap in relaon to ERPs who support investors by providing ESG rang products and ESG scales based on research analysis and rang methodologies. Recognizing that there is no uniform approach currently followed by rang agencies in evaluang ESG parameters, the capital market regulator, Securies and Exchange Board of India (SEBI) recently introduced a consultaon paper on introducing a regulatory framework for ESG Rang Providers for the Securies Market in India (Paper). The Paper primarily idenfies listed companies, instuonal investors, asset management companies and index providers as the key recipients and users of ESG rangs. It recognizes that as on date, ESG rang services are largely provided by global and established ERPs coupled with domesc enes who are largely group companies of credit rang agencies or research analysts. With that context, the Paper proposes a framework for the accreditaon of ERPs to ensure that the players in the market are referring to genuine data from reliable market intermediaries. As part of the accreditaon process, SEBI has prescribed certain eligibility criteria for ERPs, i.e. ERPs must be registered research analysts or credit rang agencies with SEBI and must meet minimum net worth requirements of INR 10 crores, possess adequate infrastructural facilies such as database collecon and management systems to provide ESG rangs and human resources who have adequate qualificaons / specializaons to provide such rangs.
13
The Paper highlights the disncon between ESG Risk Rangs and ESG Impact Rangs and stresses on the need to classify disnct products appropriately, as well as disclose the process of ESG rangs. The Paper also addresses the key controversy that shadows the role of ERPs and manifests as conflicts of interests, primarily between ESG rangs and consultancy. In doing so, the Paper suggests a range of different measures such as the requirement for ERPs to formulate a detailed conflict of interest policy, and segregate personnel who work in the ESG Rangs department from any other acvity undertaken by the ERPs, including ESG advisory and consultaon services. The Paper also considers whether ESG rangs should be provided on a sector-specific basis and leaves it open for ERPs to provide it on a sector-agnosc basis. In terms of remuneraon for ERPs, the Paper adopts a `subscriber pay' model, versus an `issuer pay' model to minimize conflicts of interests. Thoughts on the Proposed Regulatory Framework Globally, there is lile clarity in what ESG rangs or data products intend to measure. The composion of indicators within the ESG domain is largely a subjecve maer and may vary from one organizaon to another. In contrast with credit rangs, where credit rang agencies rely on more tangible data driven metrics, the assessment of the ESG metrics is based on soer uncrystallized principles. A key theme which emerges from SEBI's proposed regulatory framework is the need for disclosure of the methodology adopted for the data driven processes. For instance, some large global ERPs disclose the exact metrics against which it provides rangs to companies. These metrics could include carbon emissions, climate change effect, polluon, waste disposal, renewable energy, resource depleon, supply chain, polical contribuons, discriminaon, diversity, community relaons, human rights, cumulave vong, execuve compensaon, shareholders' rights, takeover defence, staggered boards, and independent directors. These disclosures may also specify if the rang process involved any prior engagement with the company, whether through the issuance of quesonnaires, interviews, etc. before according such rangs. In the process, ERPs may also classify whether its rangs are sector specific or sector agnosc, which may be parcularly relevant for investment decisions in sensive sectors such as pharmaceucals, metals, etc. where environmental and social hazards constute key ESG consideraons. Therefore, SEBI's proposal to require ERPs to disclose more, be it their methodologies for assigning rangs or policies around conflicts of interests, is a useful tool to encourage transparency and competency in the market. Alongside this, the fact that SEBI has refrained from prescribing any standardized rang scale will help preserve and boost the compeveness and innovaon in the evolving ESG ecosystem. That said, the requirement for accreditaon of ERPs must be revisited along with the proposal for eligibility criteria such as net worth requirements, infrastructure and man-power requirements. In an evolving regime such as ESG, the idea of light-touch and principle-based regulaon would encourage more compeon, innovaon and efficiency, as opposed to formal requirements for registraon and accreditaon.
14
Lately, we have seen magazines, journalist houses and consultants engage in ESG advisory and rangs, and these have emerged as large players. Therefore, it is not only that those with credit rang or research analyst licenses assign such rangs. Further, the significance accorded to the net-worth and infrastructural facilies of an enty as determinave of the seriousness of the organizaon is rather misplaced and acts as an unnecessary barrier. In the past few years, we have seen experienced individuals transion into impact invesng, ESG rangs, etc. from more lucrave convenonal roles, to meet personal ethical and moral objecves. While these individuals may not have the prescribed net worth to classify as an ERP, they may certainly possess the requisite skill set to engage in ESG rangs. Therefore, a light-touch principle-based regulaon coupled with increasing shareholder acvism and investor awareness, will help set the broader framework within which ERPs operate, and act as a check on the acvies of ERPs, which will in turn set the roadmap for corporate governance for the coming decades.
15
(By Invitation) Fundamental power sector reform needed to incentivise climate finance
One desirable step for India to make itself more aracve to investors is to undertake fundamental reform of the power sector around strong market-based principles. This is also essenal for an efficient carbon transion in India. The picture is not rosy For 30 years, many policy reform projects have been aempted in the power sector. A brief chronology: opening different aspects of the sector to private investment, inially generaon and subsequently transmission and to a limited extent distribuon; unbundling vercally integrated state-owned power ulies into separate enes execung generaon, transmission, distribuon, trading and regulatory funcons; introducing limited areas of market-based compeon including the creaon of power exchanges; aempng privasaon of discoms and transmission assets; some improvement in regulatory capacity, parcularly at the central level and; finally, mulple efforts by the central government to bail out and restructure discom finances. The Electricity Act, 2003 was brought in when there was almost no private parcipaon in the power sector. The reform brought about by the Electricity Act 2003 brought about privately owned independent power projects (IPPs). However, at least 4 bailouts have been required in the past 20 years to alleviate the financial stress in the sector from me to me. As a consequence, state-owned discoms remain in chronically bad financial health. Total discom losses in FY2021 were esmated at Rs.0.9 trillion with accumulated losses at about Rs.5 trillion. In March 2021 overdue payments from discoms to power generators were at about Rs.0.68 trillion. Despite increasing private investment in power generaon, and more recently in transmission, the Indian power sector remains largely a state-controlled, mandate-based environment. The overwhelming prevalence of the long-term, fixed-price, non-negoable PPA model hampers the potenally more sophiscated everyday response of market parcipants to price signals. There are many familiar problems in the sector which is currently state controlled, such as: State procurement agencies and discoms passing on risks of obtaining permissions and acquiring
land to IPPs. PPAs failing to provide adequate security for delayed payments, early terminaon, change in law
and force majeure. Aempng to force reducons in power tariffs in signed and operaonal PPAs. Discoms in various states dispung agreed price mechanisms under signed PPAs despite advice
issued by the Ministry of New and Renewable Energy of the Union government. Refusing to grant open access when required to do so by law and persisng with ligaon. Disputes on agreed contract provisions in PPAs such as compensaon in case of change in law and
force majeure events.
16
The most recent consolidated reform effort, in the shape of the Electricity Amendment Bill 2021, has posive elements but is incomplete. The aempt to introduce compeon in distribuon and provide more customer opons is significant but does not adequately take into account the market power of legacy state discoms. In a recent important report on the reform of the distribuon sector prepared for Ni Aayog, it is acknowledged that India will not be able to achieve a high-growth, low carbon economy unless the distribuon sector achieves profitability. The report highlights some key reforms considered necessary for the power distribuon sector such as the need to separate ulies from the state and increase private parcipaon. The problem could deepen In the context of climate change and consequent commitments to the internaonal community, these problems could get worse. Indian acon on emissions: India went from 4% of global emissions in 2000 to 7% in 2021. While the growth of electricity generaon and emissions averaged 5% over the last 20 years, the growth of electricity generaon in the recent period (2016-17 to 2020-21) was lower at 2.8% reflecng the difficules of the economy in this period. This low growth of emissions may not obtain in the future. Rapid growth of Indian emissions would sit uneasily in a decarbonising world. Greater pressure may come together, upon India, our COP26 announcements notwithstanding, to make progress on the long game of decarbonisaon. The investment strategy of Indian firms is affected by climate change: Private firms now face an ESG-inflected investment environment where access to debt and equity capital requires decarbonisaon in the firm and its supply chain. The cost of capital for debt or equity finance for carbon-intensive investments is higher. Firms respond to the incenves associated with internaonal asset pricing. Buyers are not content to accept carbon-intensive power from the grid, and expect the electricity system to accommodate more renewables. Internaonal trade compeveness concerns could reshape the incenves of Indian actors: Countries at a more advanced stage of their carbon transion fear that their contribuon to a global public good comes at the cost of compeveness when pied against producon in more pollung countries. This has led to the idea of carbon border taxes. In July 2021, the European Commission adopted a proposal for a new Carbon Border Adjustment Mechanism (CBAM), which will put a carbon price or tariff on imports of a targeted selecon of products. The main objecve of the CBAM, which is proposed to commence in 2026, is to ensure that European emissions reducon efforts contribute to a decline in global emissions, instead of merely moving carbon-intensive producon outside Europe. Indian exporters will see direct links between internaonal compeveness and the extent of decarbonisaon within their firm and supply chain, and within the electricity system of the states in which they operate. This will impact decisions on the queson of where producon within India takes place: private firms may avoid states which have low economic freedom in purchasing renewables and where renewables make up a lower fracon of discom supply. Internal stress in the electricity sector which renewables will exacerbate: Grid electricity in large parts of India is over-priced, carbon-intensive, and unreliable. Customers want to exit through various means, including capve or `third-party' corporate PPAs. Some corporaons face pressure from their investors to control emissions and an increasing number are making voluntary formal commitments towards achieving net zero emissions. There are strong incenves for generators and buyers to arrive at transacons that bypass the cross-subsidy system. The shrinking base of customers who can be charged high prices will create escalang fiscal stress in the electricity sector.
17
The case for fundamental reform There is a need to step back from the taccal detail of the electricity sector and its everyday policy acvies, into a more coherent policy strategy, aligned with internaonal climate change related commitments to 2030 and beyond. The problem of climate change, and the problem of electricity policy, both demand a large number of acons by numerous actors across long periods of me. In this context, power sector reform needs to be based on two main principles: Increase the role of prices in the electricity sector and privase firms in the power sector, especially the discoms. Increase the role of prices in the power sector There will be many quesons and challenges in organising the Indian electricity sector in the coming decade. How should renewables and storage be combined? How should the demand side be re-organised so as to best fit into the intermient renewables generaon? What is the role for decentralised ("micro-grid") soluons in the future, as opposed to the 20th century model of large generators and large distribuon companies? How will technology change renewable generaon, baeries, electric vehicles, etc. and how will the electricity system constantly reshape itself, with profits and losses being made by firms based on the correctness of their bets? What is the true cost of renewable energy given the existence of implicit subsidies like having must-run status and a waiver of transmission charges? The detailed design of how producon should take place is best performed through the self-organising system of the market economy, where decisions about technology and business models are made by self-interested actors that interact through markets and respond to prices. State intervenon must be narrowly designed to address market failure. The key element that is missing in the Indian climate transion is an electricity sector that operates in the price system, with supply and demand that make prices, and prices that reshape decisions of all firms and all users. Deep privasaon is necessary Numerous difficules stem from state ownership of discoms, whether in negoang risk allocaon under `model contracts' or excessive ligaon and slow judicial contract enforcement. This reduces confidence in the sector and the Indian market. Discoms have low incenves to follow economic raonality. The occasionally ambiguous and somemes proteconist treatment of state-owned discoms by the regulatory authories enables policy mistakes. For private investors, excessive state bureaucracy in the sector creates policy risk. For a sector more rooted in the price system, we need privasaon, parcularly of the discoms. Conclusion Power sector reforms will go a long way towards encouraging ESG-led investment in India's climate transion. It should be noted that despite having an apparently buoyant renewable energy sector, India receives only a fracon of global clean energy transion investment. According to BloombergNEF, in 2020, worldwide investment in renewable energy capacity hit $303.5 billion, the second-highest annual figure ever. Of this, Europe accounted for $81.8 billion, and China was at $83.6 billion. India was at $6.2 billion. Reforms will also provide a more favourable environment to introducing policy instruments such as carbon taxes, which in turn will lend stability to India's ESG investment environment. The climate transion gives us the opportunity to think boldly about India's climate transion: we should not lose this opportunity.
18
List of Contributors
TRILEGAL Team CHAPTER 01 Unlocking Green Finance CHAPTER 02 Redefining Corporate Cizenship - the road to sustainability Upasana Rao, Partner Urvi Agarwal, Associate Jayesh Kumar Singh, Intern CHAPTER 03 ESG Crisis Readiness and Response: A Toolkit Kunal Gupta, Partner Shreya Kundu, Senior Assosiate Vidushi Gupta, Intern CHAPTER 04 Regulaon of ESG Rangs Providers In India Shru Rajan, Partner Vidhi Shah, Associate
GUEST Contribuon Akshay Jaitly, Strategy and Policy Advisor, Founding Partner Trilegal and Advisor NIPFP
19
About FICCI
Established in 1927, FICCI is the largest and oldest apex business organisaon in India. Its history is closely interwoven with India's struggle for independence, its industrializaon, and its emergence as one of the most rapidly growing global economies. A non-government, not-for-profit organisaon, FICCI is the voice of India's business and industry. From influencing policy to encouraging debate, engaging with policy makers and civil society, FICCI arculates the views and concerns of industry. It serves its members from the Indian private and public corporate sectors and mulnaonal companies, drawing its strength from diverse regional chambers of commerce and industry across states, reaching out to over 2,50,000 companies. FICCI provides a plaorm for networking and consensus building within and across sectors and is the first port of call for Indian industry, policy makers and the internaonal business community. Ms Jyo Vij Deputy Secretary General FICCI E [email protected]
20
About TRILEGAL
Trilegal was founded in the year 2000 and has grown rapidly to become one of India's leading law firms. We are a top-er full-service law firm with over 500 lawyers who are led by 71 partners. Our partners and lawyers are equipped with the right combinaon of local insight and experse and ensure that we deliver cost- effecve, deal oriented and high-quality legal advice. Our core strengths are the commitment and client centric approach of our lawyers. We pride ourselves for dealing with complexity, thinking out of the box and coming up with innovave soluons for our clients. Our approach to work involves a deeply analycal understanding of Indian law and experience of the market, which allows us to effecvely calibrate/assess legal risk and provide praccal advice. The firm and its lawyers have been consistently ranked and recognised by leading legal publicaons across each of our pracce areas.
For any queries and feedback on this white paper, please contact the following Upasana Rao | Partner E [email protected] Kunal Gupta | Partner E [email protected]
21
Disclaimer
The informaon contained in this Knowledge Paper prepared by Trilegal at the instance of FICCI, is intended to provide general informaon on a parcular subject or subjects and is not an exhausve treatment of such subject(s). Neither FICCI nor Trilegal and their respecve members are by any means rendering legal advice or other professional services or advice through the material in this Knowledge Paper. This Knowledge Paper does not contain all informaon available on the subject of ESG. It should serve only as a general guide and not as the ulmate source of subject informaon. While best efforts have been used in preparing this Knowledge Paper, FICCI and Trilegal make no representaons of any kind and assume no liabilies of any kind with respect to the accuracy or completeness of the contents. FICCI and Trilegal shall not be held liable or responsible to any person or enty with respect to any loss or incidental or consequenal damages caused, or alleged to have been caused, directly or indirectly, by the informaon contained herein. The informaon in this Knowledge Paper is not intended to be relied upon as the basis for any decision which may affect any person or enty. Independent professional advice should be sought for taking any acon on any issue menoned in this Knowledge Paper. Further, this Knowledge Paper is aimed at providing informaon on some pernent topics relang to ESG in India as they stand today. This is subject to change with future amendments and modificaons. FICCI and Trilegal assume no responsibility to update this Knowledge Paper in the event of such future amendments and modificaons. The paper is finalized on 08 March 2022.
FICCI.IN
TRILEGAL.COM
