Environmental outcome as a risk factor

Environment-related risk is a source of financial risk. In 2018, demonstrations such as wildfires in Amazon basin, tropical storms in Asia besides average temperature increase in America and Europe led to $80 billion worth of insured losses. Reportedly, financial markets may experience a quick drop in asset prices (known as Minsky moment) due to climate risks worth of $20 trillion.

There is an urgent need for massive re-allocation for financing the transition towards climate risk management, net-zero world, and improving resilience and adaptative capacity of the underprivileged.

Climate change can be deeply felt by people of poor nations due to high exposure to natural resources, high susceptibility to changes and low resilience to recover from those changes. This will be perilous for India due to vulnerable climatic zones and climate-sensitive livelihoods.

To unleash resilient and sustainable development, there is a need to de-risk and encourage conversations on integrating environmental and social factors into businesses. In this context, environment, social and governance (ESG)-based financial system will play an important role in steering development on green frontier pathway as businesses that rely for investments and advances can be nudged for sincere response towards climate change.

Sustainable investment derives strengths from three key developments: Corporate social responsibility (CSR); ESG-based investing; and impact investing.

Globally, CSR investing evolved from merely philanthropic aids to corporate social performance, leading to linkages with earnings and brand value. ESG-based investing provides a better alternate for sustainability reporting and strengthening financial stability.

ESG principles include identifying and quantifying non-financial values, and integrating them into corporate governance. Impact investing intends to optimise three-dimensional metric – risk, return and impact – unlike usual investment decisions based on financial risks and returns only.

In India, non-financial reporting started in 2007, followed by National Voluntary Guidelines on ESG in 2009 and subsequently joining the UN Sustainable Stock Exchange. In 2014, impetus on intangible values relating to environmental and social factors are pushed further with mandatory CSR investing for qualified businesses. Presently, there is nearly $28 billion worth of assets in sustainable investment, though comprising of 0.1% of global share.

The consequences of climate change in South Asia such as melting glacial and coastline erosions, stand at 2,30,000 deaths and $45 billion worth of financial loss, with 50% population exposed to at least one calamity. Poor communities living in these zones and relying on climate-sensitive livelihoods become highly vulnerable.

In India, climate change such as bad air quality, dying rivers and land degradation are causing further troubles to health and wellbeing, and incurring losses in agriculture and industrial regions.

In the present world order, disruption seldom occurs in isolation. The Covid-19 pandemic is the latest disruption in everyone’s daily life as well as world economy. On the brink of global recession and setbacks to productivity, world is still counting on the increasing costs of the pandemic.

In India, illustrations such as large-scale migration, poor healthcare management and severe economic contraction in Q1 2020-21 expose the fault-lines of development, tribulations of businesses and significance of social factors for economy. In such an evolving risk landscape, ascertaining sustainability of growth process requires climatic and equity considerations.

The Indian way towards ESG Policy: The recent RBI Report suggests increasing emphasis on climate and socio-economic factors, and the ESG Policy. The key idea behind this shift is to identify businesses which are less volatile and have less chances of mishaps.

While India’s political economy supports business decisions on socio-economic factors like boosting rural credit, situation gets murkier in addressing the issues of climate change.

For instance, Environmental Impact Assessment notification 2020 draws resentment and debates on several suggested policy changes such as post-facto clearances and various exemptions. It is intriguing why there has been muddle in the policy stance at the intersection of ‘ease of doing business’ and sustainability of businesses.

Shelving projects

The recent incidents of gas leak in LG Polymers and gas well fire in Oil India reflect on debilitated environmental orientation of businesses. It is correct that shelving projects in the name of environmental concerns has nothing scrupulous. But, arbitrary will of businesses to continue on their own terms and overlook the implications of environmental negligence is also deplorable.

There should be a system that encourages integration of environmental and social factors in business decisions and ensures sustainable development.

In this regard, non-financial reporting should become a tool to assess corporate performance and emphasis should be given on triple bottom-line framework – profit, people and planet – for investment decisions.

With ESG policy in place, financial institutions can be able to monitor resource usage and efficiency, and impact on environment. Furthermore, financial system driven by ESG principles will act as a catalyst for growing impact investing and leverage on mandatory CSR. Adoption of ESG policy at the MSMEs and social business level may mitigate India’s biggest problem of access to finance. That way, social and governance factors can also be better tackled by empowering social businesses and adopting non-financial disclosures.

There are challenges in integrating the ESG criteria such as high-cost of reporting, complicated review process and credibility. In 2018, for example, the Yes Bank Ltd was one of the top 10 stocks in NIFTY-100 ESG indices. However, the Minsky moment came soon when the stock price crashed by 90% within 14 months due to serious concerns in corporate governance.

Growth process without climatic and equity considerations cannot be resilient and sustainable. Time has come to factor environmental outcomes into the risk calculus and develop a system where even if the businesses don’t care about climate change, they have to pay attention to it.

(The writer is Research Scholar, IIM-Shillong)