ESG factors now part of lending decision by top banks globally: Crisil CEO

ESG will play an even bigger role in decision making both on the issue side as well as the investor side in the longer-term, says Ashu Suyash

Last month rating CRISIL launched its environmental, social and governance (ESG) scores for India’s top 225 companies across 18 sectors. The scores are based on information available in public domain including from third-party providers. Ashu Suyash, managing director and CEO, CRISIL tells Krishna Kant why ESG score is the best measure of the sustainability of the businesses in the long-term. 

We are all familiar with businesses’ financial scores. But why should we worry about a company’s ESG score as well?

The last one and half year has been tough for businesses and the society at large across the globe. The economic and human pain inflicted by the pandemic brought sustainability to the fore. And this is where ESG factors come into play. It is the best measure of the sustainability of the businesses in the long-term. The pandemic is not yet over and businesses continue to face other long-term issues such as climate change. That’s why I think ESG will play an even bigger role in decision making both on the issue side as well as the investor side in the longer-term.

An ever greater number of long-term investors now use ESG as an investment theme. Six ESG funds that were launched in India in 2020 collected nearly Rs 3600 crore from investors. In the first 6 months of 2021 as per estimates nearly $ 5 billion have been raised as sustainable bonds. Globally nearly $100 billion of ESG flows came into markets between 2018 and 2020. And there are estimates that by 2030, ESG oriented investing could be worth $100 trillion. 

Pandemic has been a big wake-call for corporations but isn't the ESG scale dominated by factors related to energy and climate change?

ESG is not only about climate change. The challenge around energy and climate change has been around for a long-time. Recall 1984 Bhopal Gas Tragedy, Hurricane Katrina in 2005 or Fukushima Nuclear Disaster in 2011. We have 18 parameters around the environment itself in our ESG score. Besides greenhouse gas emissions, it includes water usage, waste management and land & resources use among others. But the pandemic has brought the social or the S-factor ahead.

The companies that came on top have been well resourced in terms of employee care initiatives, had the ability to provide work from home and the sufficient capability on the tech side to transition to the new work environment. So there is clear evidence that S-factor played a critical role in the success of these companies.

The product safety is also a S-factor more so during the pandemic. The product recalls due quality issues are bad for consumer safety, company's reputation and financials are important consideration. Additionally, customers’ complaints and whistleblower complaints are important considerations.

Similarly, the governance factor has also been there for a long-time. Governance failure has been a big factor in the demise of some of the biggest corporations globally. Not surprisingly, better managed companies have always commanded a premium on the bourses. 

Does the ESG score also reflect in the financial performance of the companies?

There is now clear empirical evidence globally that companies with high focus on ESG factors perform better than their peers. Their management is able to manage risks better than others and is able to spot new opportunities better. All this translates into superior financial performance over the long-term. A positive correlation in ESG scores and corporate performance can certainly be expected over the long-run. Over a longer-period and across business cycles, ESG leaders are indeed expected to outperform. 

The ESG focussed companies have delivered higher mean returns to shareholders and investors three-year and a five-year period compared to the broader market. ESG focussed companies also tend to be less volatile than the broader market.

But is there a sectoral bias in the performance of ESG100 companies. Last few years have been tough for resource intensive companies that score low on ESG for operational reasons.

It’s true that companies in resource intensive sectors – thermal power, metals, cement & energy – will have lower average ESG scores on account of high emissions and resource use. However, despite this constraints some of the leading companies in these resource and emission intensive sectors outperform average ESG scores of services sectors which indicates that some of the stronger companies are able to overcome the sector specific constraints. 

Every company would like to score high on ESG but doesn’t it require investment which may be beyond the reach of small companies?

Of course it will require some investment, but ESG factors are now part of the investment and lending decision by top banks globally. The companies with high ESG score can generally get capital at lower cost than those with low ESG score. So many smaller companies which were reluctant to make investment on ESG side in the past have realized that they may become unviable or uncompetitive over the longer term if they don’t take it seriously. More so for long term business sustainability companies would be willing to make these investments.

Besides, it is likely that a smaller company may have access to pools of capital both equity or debt from providers focused towards energy efficiency or social initiatives. And in our survey 86% of the companies consider ESG as an important factor for their capital raising plans .

Do you also see any perceptible difference in ESG score according to the ownership of the firms – family owned vs MNCs or PSUs?  

The level of disclosure plays a bigger role in ESG score than the ownership. It's not that a family owned firm will score lower on ESG than an institutional owned or an MNC. PSUs for example, have scored lower largely due to the limited presence of independent directors and frequent changes in board composition.  ESG score is a view rather than a judgement and is also a function of disclosure. Generally, the subsidiaries of MNCs of many large global companies have lower disclosures on environment and social parameters which adversely impacts their scores.  This may change as Business Responsibility and Sustainability (BRSR) Report becomes mandatory from FY23 onwards.

Now let’s turn our attention to the economy. What are the risks that you see for the Indian economy in FY22?

A slow vaccination and a potentially virulent third wave is the biggest headline risk for the economy in FY22. However, Indian economy and the corporate sector could also be challenged by a faster than expected interest hike by the US Fed and a continued rally in commodity and energy prices.

The US Fed has indicated that it will not raise rates before 2023 but if the global GDP growth and inflation is higher than expected forcing Fed to raise rates then it will hit capital inflows to emerging markets including India. And nobody wants to get caught-up in such a conundrum.

On the positive side, I don’t see RBI raising interest rates anytime soon. The central bank is sitting on record high foreign exchange reserves and liquidity in the economy remains comfortable.

How do these factors change CRISIL’s outlook for India’s GDP in FY22?

As of now we are staying with the estimate of 9.5 per cent growth in FY22. Our growth outlook looks reasonable provided by August, the economic activity goes back to the level seen in February and March this year. The estimate is based on our assumption that 70 percent of the adult population will be vaccinated by December and that the third wave would be mild and won’t be too disruptive.

However, if the third wave turns out to be severe resulting in lockdown in major parts of the country then GDP growth may be lower than our estimates so far. And that’s why we have said that GDP growth in FY22 could moderate to 8 per cent in the worst case scenario.

In all this, the silver lining is the strong recovery in global economic growth. If we look at S&P estimates, they have recently raised the global GDP growth to 5.9 percent in 2021 from 5.5 estimated earlier. The biggest factor will be the growth in the United States. US GDP is expected to grow by 6.7 per cent in 2021 and despite the recent surge in Covid-19 cases economy recovery remains on track. In the context of stronger global growth, exports will be a positive thing for India and this is already playing out.