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Mitigating ESG risks requires innovative, robust policy framework

Guest contributor Rupam Raja, partner at Transaction Servics Practice in ERM India, examines the drive for proactive evaluation and management of environmental, social and governance outcomes associated with the activities of India Inc.

As we slip into the searing heat of May in Delhi, we will probably forget just how strange this winter was in northern India. Tropical thunderstorms and lashing winds are by no means an annual fare for Delhi in March. This winter we also learned through New York Times that Delhi’s air quality is worse the Beijing’s. The news was met with some disbelief, even outrage, in Delhi. Though a large number of Delhiites suffer from respiratory ailments caused by air pollution, they like to think of it as a winter ailment, rarely making the connection with poor air quality. 

India is not known for being an environmental hotspot. In fact, India’s government has a very progressive record on environmental issues. The Ministry of Environment and Forest, the apex environmental body in the country, is known for its activist, pro-environment leadership. Several state governments in India have regulated a switch from diesel to Compressed Natural Gas (CNG), a cleaner burning fuel in the face of loud protests from the diesel lobby. More than 20 cities in India today are actively planning or building mass transit systems. So then why, inspite of this massive investment in sustainability infrastructure, are our rivers dirtier and air more polluted than it was ten years ago?

Worldwide, voluntary adoption of stricter environmental performance standards in private investments has jumped since 2008. The credit crisis in the US and its consequence forced many in the private sector to pay more attention to Environmental, Social and Governance (ESG) risk or non-technical risk. Such risk is generally not evaluated in traditional due diligence which focusses more on tangible and quantifiable legal and financial issues. And yet, the fact remains that it was non-technical risk that brought the developed world to financial shutdown in October 2008, raised BP’s bond yields by upto 8.7% after Deepwater Horizon oil spill in Gulf of Mexico, and forced Tata Motors and Vedanta to cut and run in West Bengal and Orissa respectively. 

In 2013, globally, financial institutions (FI) which are signatories to UN Principles of Responsible Investment (PRI), a voluntary environmental performance standard for FIs have approximately USD 30 trillion worth of Assets Under Management (AUM). Investors have begun to show increasing awareness of their ESG responsibilities and not just their fiduciary ones. There is also greater awareness that good ESG practices are good for the balance sheet and long term health of the business. For foreign project investments coming into India, evaluating non-technical risk, be it sensitivity to surface water receptors, impact of future regulations on GHG emissions and relationships with the surrounding community, is a routine measure. Often such assessments involve successively more intrusive and more thorough studies aimed at getting a better understanding of the ground issues. These companies are not necessarily philanthropic ventures, international aid driven schemes or even impact investors. These are mainstream foreign investors for whom financial returns and risk management are just as important as for any homegrown, Indian company. 

Most Indian companies, on the other hand, operate in the absence of a regulatory requirement to measure non-technical risk. Moreover, the lack of awareness or concern from the investor base makes most Indian companies to trust their ability to “manage” such risk if something were to go wrong. There is only one FI signee to the UN PRI in India with an AUM of approximately USD 1 billion. Even where environmental assessments are required by law, there is enough evidence to suggest that companies are engaging the lowest cost service provider with the intention to meet the minimum requirement for compliance. Not surprisingly, in instances where project approvals are getting delayed, it is often because of the poor quality of assessment. Once the permit is granted, the government does not have the systems and processes for ensuring compliance with conditions under which the approval was given in the first place. For example, a recent approval to a mining project in Andhra Pradesh came attached with 64 conditions. The document is duly copied to 10 different state and central entities. Project developers however are well aware that inspite of the large number of regulatory institutions that are made cognizant of the conditions, there are no defined institutions or processes to enforce compliance post approval.

Given this practical consideration, the project developer takes the approval as the end of its environmental obligation considering the issues going forward to be “manageable”. However, if the asset goes into the operations without a plan for meeting the stipulated environmental conditions, it is already exposed to risks that can only be managed, not mitigated.

Typically, a large infrastructure project is planned for at least a 30 year life span. Given the evolutionary nature of India’s regulatory framework, there will be innumerable changes in policy and personnel during this time period. While operations and maintenance staff may have exemplary management skills, senior management, the board, and most importantly the investors in India Inc. should have to worry about the total cost incurred in managing issues over the lifetime of the project not to mention the business interruption risk, fines and penalties and the risk to reputation.  

India is entering an era of increased ESG regulations. The government has been forced to take a bigger role with the regulations since India Inc. failed to take the initiative vis a vis meaningful self governance towards ESG issues in the face of continued deterioration of the physical environment. In my opinion, it is bad policy to give more responsibility to a government that is dishonest in fulfilling its current ones. India Inc. however is unable to make this argument due to its own dubious record on environmental matters. India’s industry has long demanded that regulatory framework for environmental approvals should be demolished or diluted because these regulations are holding up large infrastructure projects that if approved, will revive economic growth.

While environmental approval process in India is by no means above board – the process is unpredictable and susceptible to manipulation and remains a risk for investors – the fact remains that many projects that have approvals have not been implemented. In the thermal power sector alone the environment ministry approved 217,794 MW whereas the actual installed capacity was only 53,000 MW. The number of thermal power projects approved by the Ministry in 11th Five Year Plan was more than the combined target of 11th and 12th Plans. What compels India Inc. to seek demolition of safeguards that protect public interest remains anyone’s guess.    

India needs a robust debate on government’s role in the emerging economy. It is vitally important that the private sector participates in discussions to formulate meaningful policy that eventually leads to a smaller, more efficient government, encourages participation of the people and private sector in the economy and protects our environment. However to get there, India Inc. needs to start taking a more proactive approach towards evaluating and managing the environmental, social and governance outcomes of its own actions. 

Rupam Raja is Partner at the Transaction Servics practice at ERM. His team assesses non-technical risk aka ESG risk in greenfield and M&A transactions in India.

Images: Flickr/ Basheer Tome, Nevil Zaveri
Author: Sustainability Outlook