The acronym “ESG” (environmental, social, and governance) seems to be everywhere nowadays. All over the world, companies are ramping up their ESG efforts and allocating more funds and resources to improve their ESG reporting capabilities. The increased focus on ESG is not only due to government regulations or a result of the pressure brought on companies by their investors.

While these drivers do play a role in pushing ESG into the spotlight, organisations – particularly purpose-driven ones – are paying more attention to ESG factors because these factors can drive top-line growth and sustainability, differentiate a firm from its competitors, and create more value for stakeholders including investors and employees.

A strong ESG proposition can also drive higher equity returns, reduce risk and costs, and even enhance employee productivity. These potential benefits are available to firms in every industry and every country – including India. For all these reasons, McKinsey believes that ESG is much more than a “fad or a feel-good exercise”. Simply put, ESG matters. And it’s here to stay.

What is ESG?

ESG refers to operational criteria, standards, or factors covering three key areas: environmental, social, and governance. An organisation’s ESG programme would include many of these criteria that would guide and support its risk management activities in all these areas. These criteria also provide a way for socially- and environmentally-conscious investors to evaluate the company’s efforts in these areas and assess whether it is a suitable potential investment. Many investors want to invest in green companies and companies that make meaningful social contributions. This is one of the most compelling reasons for firms to improve their performance along ESG criteria like:

• Their carbon footprint
• Pollution caused by operations
• How they dispose hazardous waste
• How they manage waste and resources like water and energy
• Their role in climate change and ecological damage
• Whether they respect human rights
• Whether they use natural resources responsibly and sustainably
• What accounting methods they use and how they disclose performance
• Whether they have a diverse board
• Whether the company is inclusive and behaves ethically

In general, environmentalcriteria consider whether the firm is aligned with its industry’s or country’s commitments to environmental protection and sustainability. Social criteria focus on examining whether and how it manages its social responsibilities, such as its relationships with employees and the broader community. Finally, the governance factors in ESG refer to the firm’s governance controls that are essential to promote accountability and transparency, help leaders to take better decisions, and empower the firm to meet stakeholder demands.

All in all, ESG is about creating companies that are socially responsible, ethical, and proud to function as stewards of the environment. It takes time to create such firms. But the effort is always worth it. Let’s see why.

How Companies Can Benefit by Focusing on ESG

According to McKinsey, ESG is increasingly an inextricable part of how many companies do business, which is why the concept has gone “mainstream” and is constantly gaining both support and traction worldwide. That said, there are ESG naysayers and critics as well. Most of them criticise ESG because they consider it an unnecessary distraction that prevents companies from doing what they are supposed to do – make money.

Other critics believe that it’s not easy to meet the technical requirements of ESG and generate value for all stakeholders even after meeting these requirements. A third objection to ESG is that it is not measurable so its impact is not easy to assess. Still others believe that there’s no meaningful relationship between ESG and financial performance so there’s no point adhering to its criteria and controls.

McKinsey and other researchers have proved that all of these worries and criticisms are irrelevant. Companies that focus on ESG and create strong ESG propositions can generate many benefits for themselves and their stakeholders. For one, they can tap new markets and expand into existing ones, thus driving greater growth. They can also build greater social capital, which will allow them to achieve higher valuations than their competitors. Moreover, they can attract more customers, particularly those who are willing to pay more for products that are greener and ethically sourced, which again will add to their revenues and drive more growth.

ESG can also reduce costs and help firms to optimise their capital expenditures and investments. They can minimise regulatory and legal interventions, and thus decrease their chances of receiving costly fines or other kinds of punishment from the government or from regulatory agencies. They can even engender government support, which can be particularly crucial in highly regulated industries like financial services, pharmaceuticals, and healthcare.

A strong ESG proposition can also help firms to attract and retain quality talent and enhance workforce motivation and engagement. Employees working for ESG-focused companies have a sense of purpose that inspires them to perform better and be more productive at work. Needless to say, productive employees are productive – and successful – companies.

Smart organisations understand these benefits of ESG. More importantly, they understand the links between ESG and their own growth story. That’s why they make ESG an inseparable part of the company culture and its very DNA.

ESG: World vs. India

All over the world, ESG issues have become pressing for policymakers, boards, and executives. However, the focus on ESG is not uniform worldwide. One reason is that not all governments have introduced mandatory ESG reporting for companies. One 2021 study by the Harvard Law School found that only 25 countries had introduced mandates for firms to disclose ESG information to the public. The researchers also found that the adoption of mandatory ESG regulation is more common in countries that have common law origins and/or higher per capita carbon emissions.

That said, enthusiasm for ESG adoption and reporting is growing. The World Economic Forum reports that since early 2021, over 150 companies have committed to support the Stakeholder Capitalism Metrics – a set of universal metrics and disclosures that enable for-profit companies to consistently disclose non-financial factors for investors and other stakeholders. Firms can use these metrics to align their reporting on their performance against ESG indicators and show what efforts they have made towards sustainable value creation.

In India, it’s still early days for ESG due to the lack of regulatory and investor pressure on Indian and India-operating companies. Still, the ESG ecosystem is rapidly growing and will continue to grow over the next few years. One reason is that India is one of the only countries in the world that has a corporate social responsibility (CSR) mandate for companies, making it a major market for ESG-friendly initiatives like green finance and sustainability solutions. Another reason for India’s expanding ESG landscape is that the securities regulator SEBI recently made it mandatory for the top 1,000 listed companies to furnish sustainability reports from FY2022 onwards. Other regulators could follow suit in the near future.

The growing push towards ESG worldwide is prompting many Indian firms to make ESG part of their overall business strategy. Many are also willingly disclosing their ESG profiles and publicly sharing their roadmaps for ESG incorporation and improvement. Of course, there isn’t the same level of scrutiny of ESG reporting in India as there is in other markets such as the EU, UK, Australia, and USA. Also, despite SEBI’s mandate, mainstreaming mandatory ESG disclosures among Indian companies still has some way to go. A lack of sectoral guidance and a lack of information about the descriptive responses required as part of ESG disclosures for Indian regulators mean that these disclosures and reporting are yet to fully take off in the country. That said, once these issues are resolved, ESG will become a critical corporate concern in India, just as it already is in other global markets.

Conclusion

According to McKinsey, more than 90% of S&P 500 companies now publish some kind of ESG reports. This number will increase even further in the coming years as ESG gains traction in more countries. In addition, smaller companies and many more industries will start taking ESG more seriously and the environmental and social components in particular will gain more prominence. Considering that the links between ESG and value creation have already been established, more companies will leverage ESG as the differentiating factor that sets them apart from the rest.