A New Lagaan On India Inc.

Gautam Adani was the world’s third richest man in January. Having surpassed billionaires Jeff Bezos, Bill Gates and Mukesh Ambani in the world’s richest list, the chairman of the Adani group seemed unstoppable on the stock markets. But then Hindenburg Research struck the group with its damning report, calling the rise of Adani as one of the biggest corporate cons in history. Within days stocks of Adani companies started crashing.

The US-based research firm alleged that the Adani group was involved in stock manipulation and misreporting financial parameters, which led to overvaluation of the group companies. The Adani group also faced charges of conflict of interest on account of involvement of group promoter Gautam Adani’s brothers Rajesh and Vinod in bribery and tax-evasion cases. The report forced the company to stall its Rs 20,000 crore follow-on public offer despite it having been fully subscribed.

But this was not the end of the problem for the Adani group. Its companies now face scrutiny from environment, social and governance (ESG)-compliant funds and research firms that hold the power of grounding Gautam Adani’s green dreams, a business plan that was at the heart of India’s green transition over the next decade. It is important to note that every point raised by Hindenburg in its report against the Adani group is part of the ESG framework that has become the driving-point of investors in the West.

The West’s Quest for Sustainability

The ESG framework was derived around two decades back as a voluntary movement to reform Western capitalism, which faced criticism on account of destroying earth’s fragile ecosystem by promoting wasteful expenditure through consumerism.

Twenty-five years after the first World Climate Conference recognised climate change as a serious challenge, then UN secretary general Kofi Annan urged the CEOs of top 50 financial institutions in 2004 to adopt ESG parameters in their decisions of investing in capital markets. In 2006, the UN developed the Principles for Responsible Investment (PRI) to push the ESG agenda further. Despite initial reluctance from fund managers, things seemed to settle in favour of having a global accountability framework after the 2008 global financial crisis wiped out the wealth of many investors. By January 2010, US capital market regulator Securities and Exchange Commission had issued Interpretive Guidance on Disclosure Related to Business or Legal Developments Regarding Climate Change. The guidelines required a company to disclose “the impact that business or legal developments related to climate change may have on its business”.

By 2014, the European Union had adopted the Non-Financial Reporting Directive, asking large companies to disclose information on ESG criteria. Further in 2018, it introduced sustainable finance guidelines, which established a taxonomy for sustainability in business in the region.

Investors across the world have come to terms with the need and value of the ESG framework, which requires them to think green and accountability while dreaming of money. As of March 2021, the collective assets under management (AuM) represented by the 3,826 PRI signatories stood at $121 trillion. On the ESG front, a report by global consultancy firm PwC expects the AuM to reach $33.9 trillion by 2026, as compared to $18.4 trillion in 2021. “ESG assets are on pace to constitute 21.5% of total global AuM in less than 5 years,” reads the report. This is huge money. To put things in perspective, the AuM in the Indian mutual funds industry as of February 2023 was just $490 billion.

Sword of Damocles

The West turning to an aggressive ESG framework has made it obligatory for Indian companies to follow suit or miss out on opportunities offered by global capitalism. Any company looking to raise money from global investors needs to be ESG compliant, as every significant international institutional investor is looking to assess the ESG score of the potential investee.

Though reluctantly, the Indian government has fallen in line over the years, coming up with rules that nudge companies to be ESG compliant. In 2009, the Ministry of Corporate Affairs issued the National Voluntary Guidelines (NVGs) on corporate social responsibility. In 2012, the Securities and Exchange Board of India (SEBI) asked the top 100 listed companies by market capitalisation to start filing business responsibility reports under the NVGs. In 2015 and 2019, the mandate was extended to 500 and 1,000 listed companies respectively. In 2021, SEBI proposed guidelines for the mutual fund industry, asking ESG-based funds to keep 80% of their assets in securities that follow the sustainability theme. In the same year, SEBI also developed the new, more comprehensive concept of reporting in the form of business responsibility and sustainability reports (BRSRs).

The most important fact of the evolving ESG framework in India now is that the ESG reporting is not voluntary anymore. From FY23, the top 1,000 companies have a mandatory requirement to report ESG compliance of their businesses.

With global climate negotiations having reached their zenith at the COP26 summit, forcing countries like India to commit to define net-zero emission targets, there is a sword hanging over India Inc. that can finish a company’s business prospects in no time, and Adani is just a trailer of the horror movie that Indian businesses would not enjoy watching in the coming years.

Problem of the Pyramid

“The ‘E’ and the ‘S’ of the ‘ESG’ are more metrics-driven whose performance indicators are better established, which makes disclosures relatively straightforward. [However,] there are sharp sensitivities around the ‘G’, especially when it is related to internal barriers for good governance, often leading to denial,” says Dipankar Ghosh, partner at BDO India—a global network of finance professionals and organisations—in the context of corporate governance which is often identified as the Achilles heel of India Inc. “The ‘G’ being the key enabler of integration of sustainability into business, organisational leadership needs to acknowledge and eradicate such barriers,” he adds.

Many call it the Indian way of doing business where corporate governance has been abandoned at the altar of complex, and often opaque, subsidiary structures of companies, concentration of promoter ownership and instances of questionable related-party transactions. “While there are compelling reasons for formation of a company group, complex company group structures raise a number of challenges for regulators,” reads a recent OECD report on corporate structures titled Company Groups in India. The OECD, or the Organisation for Economic Co-operation and Development, is a global policy forum whose findings influence global corporate behaviour.

SEBI has been at it for some time with several regulations to improve transparency, but without meeting governance standards, no corporate ESG regime can be complete, making companies untouchable to foreign investors, the case in point being the Adani group.

While the “G” of the “ESG” remains shrouded in mystery at many instances, experts point to a bigger problem. Beyond the top lot of the listed Indian companies, there is a serious problem with understanding and documenting the ESG frameworks within organisational structures and processes. “It will be easy for the top 200 companies to file BRSRs, as they have the money and the expertise to do it. But I do not think that the bottom 200 companies will find it easy to do so. The BRSR format is comprehensive and prohibitively expensive to implement. A large number of Indian companies will find it difficult to collect the actionable data on the ESG compliance,” says Praveen Garg, senior advisor, ESG and climate change, at the National Productivity Council. He has overseen the evolution of India’s ESG regulation mechanism as a joint secretary in the ministries of finance and environment. “We need to have something called ‘BRSR lite’ for companies at the bottom of the pyramid. Otherwise, corporates will struggle to report [ESG compliance]. They may also end up facing penalties for misreporting in the future,” Garg adds.

Echoing Garg, a report published by advisory firm Sculpt Partners in June 2022 said that a majority of the NIFTY 500 companies were likely to struggle to comply with SEBI’s mandatory BRSR guidelines. The report said that only 172 out of 500 companies had a structured reporting standard that could provide information on the sustainability aspect of their businesses.

Many people believe that regulations should be accompanied by incentives, especially when it comes to compliance with complex global frameworks like ESG. Adoption of a strong sustainable framework may require significant capital expenditure, as Garg notes, and the benefits may not be seen on the bottom line for a few years. Most Indian companies may not have the financial resources or the long-term vision to invest in such frameworks. Although there has been talk about government intervention, it does not seem inclined towards supporting the private sector by way of incentives. “The government has a clear philosophy that subsidy should go only to the poor, and corporates should fund themselves,” says a chief sustainability officer of a top corporate house on conditions of anonymity.

Add to this the policy flip-flop for domestic industry and the issue becomes more difficult to be resolved. The Indian auto sector is a prime example of this.

Over the last decade, Indian automakers have been subjected to investing in greener technologies without any assurance of a timeframe for return on capital. As global standards changed, Indian automakers had to shift from Bharat IV to Bharat VI. The woes of this transition are well documented.

Currently, automakers are fighting amongst themselves to seek government favours on different technologies available in the market. While Suzuki, India’s top automaker, has been seeking government support on hybrid cars, companies like Tata, Hyundai and Mahindra & Mahindra are lobbying with the government to promote only electric vehicles. “All this is happening because the Indian government is not sure what will help it meet its emission reduction targets,” says a senior executive at an automobile company, requesting anonymity.

Vinod Aggarwal, MD and CEO of Volvo Eicher Commercial Vehicles says, “While there is substantial technology development to be done, there is scope for multiple clean fuel technologies to grow in India serving unique needs of different applications.” He adds, “Electric is best suited for light vehicles for city driving, but when it comes to heavy duty trucks that are meant to travel on long routes, green hydrogen-based vehicles have the potential to offer optimised range and payload capacity.”

Uniquely Indian

India was a late entrant to the West-driven globalised world. It took the country about a decade to start benefiting by becoming a cog in the wheel of global supply chains. But, by the time India started understanding the game, the West changed its character in a way that economic growth was now seen through the prisms of sustainability and strict targets to control carbon emissions irrespective of the availability of capital or the per capita income or emission of a nation. In 2010, when the West started exploring the idea of sustainable growth, the per capita income of the European Union region stood at $32,969 and the US was at $48,650. India, which was at just $1,350.6, is targeted on the grounds of total carbon emissions on an annual basis, which have been rising since the late 1990s. According to the World Bank, India’s per capita carbon emission at 1.8 metric tonnes in 2019 was lower than the global average of 4.4 metric tonnes and 14.7 metric tonnes and 6.1 metric tonnes respectively of the US and the European Union.

For a capital deficient country like India, the Western rules for the ESG evaluation are unfair; the metrics for the “E”, which mainly stands for emission cuts, and the “S” for Indian companies are calculated on actual costs and not on purchasing power parity. At a discussion organised by the National Productivity Council in November last year, SEBI chairperson Madhabi Puri Buch had exhorted the Indian industry to build its own ESG framework. “There is a need for the industry as a whole to start developing the [ESG] metrics starting with an understanding of the purchasing power parity in each sector,” Buch had said, adding, “The emerging market narrative has to be as much about our needs as about global alignment.”

For India to strike a balance between its domestic preferences and meeting the global expectation, the country needs accurate data, and for this to happen, Indian companies need a well-defined evaluation process that is “made in India”.

While India is doing its best to keep pace with the West, its position in this game draws an analogy from Bollywood movie Lagaan, in which a group of villagers are forced to take up the challenge to defeat British officials in a cricket match, failing which they would have to pay three times the tax on their crop yield. India may be seen as the Mecca of cricket today, but the villagers who took up the challenge in the movie had never touched any cricketing gear before.

The West is not satisfied with how Indian companies report their ESG targets, and its targets are getting stricter by the day. Moreover, in the absence of any one set of global reporting systems, Indian companies are forced to rely on global private agencies to obtain ESG ratings for their businesses. Some top Indian conglomerates like Tata Consultancy Services, Mahindra & Mahindra, Hindustan Unilever and Reliance Industries, among others, hold top rankings on global sustainability indices, like Dow Jones Sustainability Indices and FTSE4Good Index Series, but it is not enough to give India space at the global high table. In 2022, India featured at the bottom of a list of 180 nations in the Environmental Performance Index developed by the Yale Center for Environmental Law and Policy and Columbia University. And there are many more such reports. With the narrative turning against Indian companies, it will either have to compromise and cut down on its fossil fuel consumption—which will adversely impact its gross domestic product (GDP)—or choose an economic model that will result in higher debt on the nation and its corporations.

Margins of companies in India’s core sectors like cement, steel and automobile are already under pressure due to rising input cost and the inability of customers to pay higher prices. Steel sector, which contributes more than 2% to India’s GDP and is important for its infrastructure-driven growth model, is likely to face the heat with companies looking at declining margins of earnings before interest, taxes, depreciation and amortisation (EBITDA).

Sheshagiri Rao, joint managing director and group CFO of JSW Steel, says that the cost of reducing carbon footprint by the steel sector will need to be borne by the companies, as consumers do not have an appetite for higher prices anywhere in the world, including India. “Producing steel through less carbon-intensive technologies requires huge investment. As long as it was voluntary, companies were fine, but now with industry specific targets coming up to keep up with India’s 2070 net carbon-neutral targets, it will need to be seen how the policy framework assists Indian companies,” he says.

The situation in the cement sector is similar. Dalmia Bharat Cement’s head of ESG practice and chief risk officer Arvind Bodhankar explains, “The cost of carbon capture and utilisation for one tonne of CO2 using the available technology is approximately $55. This process will increase the price of cement by almost 25%. If you look at the price increase in the cement sector in the last decade, it averaged around 1% to 3% year on year. So, in this scenario, it will be difficult for the industry to absorb the costs of CO2 capture that meet the standards of the green economy.”

With an ever larger chunk of global funding getting tied to ESG-rankings, India’s only choice is to follow the path shown by the West. This means that India will have to cut down its exposure to coal-based power, which accounts for just under 50% of its installed power generation capacity. India’s dependence on coal is unlikely to come down if it wants to sustain its targeted GDP growth rate of 7% to 8% over the next decade. While the Centre is under pressure to reduce the production of coal-based power, any decision in this direction will directly increase the cost of production for the Indian industry, which pays one of the highest costs for electricity in Asia.

India’s Green Finance Losses

Even as India juggles between coal and renewable energy resources, the European Union and the US are taking the lion’s share of sustainable funding. A 2021 report by the UN Conference on Trade and Development, which analysed the 2020 data, pegs Europe’s share in the allocation of the sustainable fund portfolio at $458 billion, or 26% of the global sustainable fund investments. It finds sustainable investments in North America at 17% of the market at $303 billion. The developing and transition economies, on the other hand, got just 3%, or $54 billion, of the total sustainable funds portfolio. India’s amount in this share would be miniscule.

Since then, the AuM of sustainable funds have risen substantially, and so has Europe’s share in it, so much so that the whole ESG regime appears like a Europe-centric ecosystem in which others just have to play their marginal roles. Market research firm Morningstar’s Global Sustainable Fund Flows report claims that Europe had $2.1 trillion, or 83%, of total global sustainable fund assets at the end of 2022. It also notes that sustainable funds managed 20% of all fund assets in the continent in 2022.

Turning green is an expensive proposition, and the West has not kept its commitment to help India turn green through transition support funds. “As per the [2009] Copenhagen accord, developed countries committed to a collective goal of mobilising $100 billion per year by 2020 for climate action in developing countries in the context of meaningful mitigation actions and transparency on implementation. As per an OECD report, only $68.1 billion of public financing was mobilised by 2020, and a majority of it came in the form of loans. Of this, India will receive $528.9 million for seven designated projects. When compared to the scale at which India operates, this is nothing,” says Bodhankar.

The West has been able to make great strides on the ESG front due to the availability of an increasing pool of green finance. The first ever green bond was issued way back in 2007 by the European Investment Bank. In 2021, the US was the number one destination for raising money through green bonds and accounted for $81.9 billion of issuances, according to data collated by the Climate Bonds Initiative. China, with its capacity to raise capital in any form, came second, accounting for $68.1 billion worth of green bonds, followed by Germany and France at $63.2 billion and $36 billion respectively. India, despite its needs for large capital to control its greenhouse emissions as per international targets, was a laggard, managing to raise just $6.8 billion worth of green bonds in the corresponding period. The Reserve Bank of India has been trying to up the game and issue higher amounts of bonds year on year, but the demand exists largely for dollar-denominated bonds, which is indicative of the fact that the US is where the power of green finance lies.

Interestingly, despite India’s need to reduce greenhouse gas emissions across sectors, 90% of the green finance is coming in the country only in the energy sector. Transportation, real estate, agriculture, textiles and other important sectors cumulatively account for just 10% of the total green bond market.

Only the top Indian conglomerates have managed to raise funds under the green finance category so far. Adani Green Energy, before the Hindenburg report on the Adani group was published, was the largest issuer of green bonds in India with transactions worth $135 billion in 2021. The Hindenburg report hit the company hard and its bonds worth $750 million yielded 31% in international secondary markets, as against the issued coupon of 4.3% in the primary market.

Aware of the shallowness in the ESG-related debt and capital market, the government is bringing in new measures. In an attempt to align itself with the Capital Market Association’s Green Bond Principle, the Centre published the Sovereign Green Bond Framework in October 2022. So far this year, the government has issued green bonds worth $2 billion in four tranches with five- and 10-year maturities.

Some analysts see hope in these measures. “India as a market still has not evolved to the extent the West has. That said, in India, both domestic and foreign investors are getting conscious about the positive impact of investing in ESG-compliant companies, as they believe that these companies will have better shareholder returns in the long run,” says Jinesh Gopani, head of equities at Axis Mutual Fund.

Geoeconomics of ESG Regime

The war in Ukraine has changed the way major global power blocks deal with each other politically and economically. A sense of protectionism is palpable even among the proponents of globalisation, and the global ESG regime is under pressure to accommodate these trends. The US and the European Union have created non-trade barriers that are likely to make it difficult for other countries to do business in their regions on fair terms.

The European Union’s Carbon Border Adjustment Mechanism (CBAM) has already sent ripples among developing nations like India, Brazil and South Africa. The CBAM seeks to impose penalties on companies that cannot substantiate the carbon emission cuts of the level achieved by European producers. This means that if an Indian cement or steel firm has a larger carbon footprint than a European steel maker, the importer of Indian steel will have to pay a penalty for purchasing it, rendering it less competitive.

“India has a target of becoming carbon neutral by 2070, while the European Union’s target is 2050. Why should an Indian company be penalised for not meeting the standards of a European company?” asks Rao of JSW Steel.

The US has a more potent protectionist tool in its kitty in the form of the Inflation Reduction Act, which makes way for heavy subsidies to local industries in the name of fighting inflation and climate change. The law contains $500 billion of new expenditure and tax breaks in the name of boosting clean energy, reducing healthcare costs and increasing tax revenues for the US government. The act has provisions for giving special treatment to local manufacturers and countries with friendly free trade agreements. India’s choice to remain neutral in the Russia-Ukraine war could cost its companies heavily if they do not get preference for supplying products to the US government-funded projects.

Rao is worried about these non-tariff barriers to free trade. He says, “Indian companies will have to deploy a huge amount of capital to expand their export capacity on the terms and conditions set by Western countries. They gave subsidies to developing countries for adopting green technologies, but that has been insufficient. The transition of India Inc. will become very difficult unless, as a nation, we are able to negotiate a good deal on these fronts.”

Sunitha Raju, professor at the Indian Institute of Foreign Trade, however, believes that India should not be sceptical about CBAM as it is intended to stem leakages in carbon reduction targets set under the Paris Agreement on climate change and hence the proposed penalties for less efficient companies. “At the same time, we need to acknowledge that there are certain segments which fall under the discriminatory category, as they subsidise local industries through permitted carbon emission allowances, forcing other countries to match their carbon pricing. India and other developing nations should negotiate on those clauses without rejecting the entire CBAM policy, because it is in the interest of everyone,” Raju adds.

The exposure of the Adani group to the punishing global ESG framework is the first major catastrophe for an Indian corporate, but, observers say, things will not rest with one group if the Indian industry does not wake up to the new global reality. If the mighty like the Adani group can fall, other Indian companies should take note with immediate effect.

Home to 1.4 billion people in the world, India has a long way to go before providing an above-subsistence-level lifestyle to a large size of its population. The country, despite having the coveted tag of being the fastest growing major economy of the world, lags on most human development indices. Developed nations’ belief in sustainable growth comes after centuries of unsustainable growth strategy that helped them accumulate wealth needed for this philosophy. The amount of subsidies their governments are deploying to turn industries green is unprecedented.

For India Inc., the situation is starkly opposite. While the Centre is trying to adopt an international ESG reporting framework for domestic consumption, though without an ability to subsidise it, we may have to settle with humble growth targets or meet the fate of Adani’s green dreams. And, unlike the happy ending in Lagaan, native Indian players do not seem well placed to earn an unexpected victory in an ESG match with the West. If things do not change, there will not be a sociologist proclaiming that ESG is an Indian game accidentally discovered by Europe!