Across the world, there is a growing demand on corporations to focus on sustainable development goals and strengthen the social responsibility of business. Working in sync with each other, while Governments are taking initiatives to bring legislative changes, investors also have started to value and consider such factors as key parameters for making an impact with their investment. The investors (such as private equity funds, venture capital funds, social venture funds, banks, financial institutions) are looking towards going a step further to not just focus on monetary returns but also achieve positive social and environmental impact. The impact of COVID-19 has already created ripples in the society to switch focus on various social goals.
Against this backdrop, the framework in India has progressed significantly with increased accountability for directors, key personnel and more disclosures relating to businesses. A series of efforts have been taken by the Indian Government, one of which requires spend of 2% of average net profits by India Inc. (certain eligible companies) towards corporate social responsibility (CSR) activities in eligible areas such as eradicating hunger, poverty and malnutrition, promoting health care, education, gender equality, including environmental sustainability. The move to introduce CSR regime went beyond philanthropic activities to create a systematic model to create impact in society. The CSR objective of the Government works in sync with the Government’s focus on expansion of disclosures on environment, social and governance (ESG) reporting by Indian listed companies. In fact, a company’s reporting of performance on sustainability related factors has become as vital as reporting on financial and operational performance.
Given the above context, this article analyses the interplay between the CSR and ESG regimes in India and how the corporations and investors would be impacted by these measures.
Development of social responsibility of businesses: CSR model changed from “comply or explain”, to “comply or penalty”
The first milestone in the evolution of identifying social responsibility of businesses was release of the Corporate Governance Voluntary Guidelines in 2009 by the Indian Ministry of Corporate Affairs (MCA), to encourage corporates to voluntarily achieve high standards of corporate governance. This was followed by the release of the National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business (NVGs) in 2011, which were subsequently used by the securities markets regulator in India, Securities and Exchange Board of India (SEBI) to frame the Business Responsibility Reports in 2012 and top 100 listed companies by market capitalization were mandated to file such reports. Later, in 2015 the mandatory reporting was extended by SEBI to top 500 listed companies by market capitalization.
With the enactment of the Indian Companies Act, 2013 (CA2013), the concept of CSR spending achieved legal recognition and apart from Section 135 of CA2013 which deals with the requirement, conditions and compliances for CSR spending, Section 166 of CA2013 also emphasized on the obligation of each director to act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of not only the company, its employees, shareholders, but also the community and for the protection of environment. In 2019, MCA revised the NVGs and formulated the National Guidelines on Responsible Business Conduct, which lays down nine principles of business responsibility.
Section 135 of CA2013 and its rules were recently amended on January 22, 2021, to provide that spending CSR amount will be mandatory and mere statement of a reason for not spending the required amount on CSR activities will not suffice. However, keeping in view that not all CSR activities are likely to be completed in the same year of its commencement, any unspent CSR amount for the financial year has been classified into two buckets, one relating to ongoing projects and another relating to non-ongoing projects. In either case, there is a sunset period within which the unspent CSR amount for each financial year is to be transferred to the specified Government fund or unspent CSR account opened by the company.
To further encourage CSR spending, the amount spent in excess of the CSR obligation of 2% (two percent) of the average net profits of the company can now be utilized to set-off against the CSR obligation of 3 (three) subsequent financial years. To further ensure that CSR amounts are spent in the manner intended under the CA2013 and the rules framed thereunder, the new revised rules require the Chief Financial Officer of the company to certify that the CSR funds have been disbursed and utilized in the manner as approved by the board. Even the annual disclosure report has undergone changes and now more detailed information about the CSR projects, allocation of CSR funds, unspent amount, excess spending, carry forward, etc, are required to be reported.
ESG reporting: Impact investing
Varied set of investors are looking to invest in assets which have ESG integrated or sustainable investing model. Their intent is not to just make profits but make impact on social and environment fields. The increased focus of stakeholders seeking corporations to be responsible and sustainable towards ESG goals have witnessed Governments actioning various legislative changes.
In the Indian context, SEBI recently on May 5, 2021, replaced BRR reporting with the Business Responsibility and Sustainability Report (BRSR) which imbibes the ESG principles. To begin with, BRSR has been made applicable to the top 1,000 listed entities (by market capitalization calculated as on 31st day of March of every financial year), for reporting on a voluntary basis for financial year 2021 –22 and thereafter on a mandatory basis from financial year 2022 –23. SEBI has prescribed a detailed format and guidance note for BRSR and requires listed entities to disclose on their performance against the following nine (9) principles of the ‘National Guidelines on Responsible Business Conduct’ (NGBRCs). The reporting under each principle is divided into essential and leadership indicators. The essential indicators are required to be reported on a mandatory basis while the reporting of leadership indicators is on a voluntary basis.
Principles of ESG Reporting
Some of the key disclosures under the new BRSR include disclosures relating to environment, waste generation and management, employees/ workers employed including benefits given to them, occupational and health safety management systems implemented, safety related incidents, process used to identify work-related hazards, measures taken to ensure safe and healthy work place, consumer complaints, product labelling and recall, CSR, details of fines/ penalties paid in proceedings with regulators, etc.
A systematic disclosure on BRSR will help the stakeholders assess and mitigate the ESG risks, and at the same time, also require the companies to put system in place to ensure that ESG reporting is true and correct as many investors will base their investment considering ESG as a key factor.
Way forward for corporate India and investors
Now that the interplay between CSR and EGS norms has been established, the revised CSR norms and ESG reporting are likely to help stakeholders in understanding the compliance by companies of the laws relating to ESG. While the benefits of CSR and ESG reporting are immense, on the corporate law legal advice front, corporates need to be careful of what they disclose and ensure that the disclosures are in line with the current legal requirements relating to labour, environmental law, consumer law, etc. The interplay between ESG and CSR will also act as potential tools to engage into meaningful conversations with the stakeholders and create value. While in the beginning, ESG and CSR have been made applicable to certain limited corporations, however, with its results and impact, its reach may well be expanded to other entities as well.
ESG may be in its nascent stage at the moment, however, with the global economies’ focus shifting to sustainable development, reducing carbon footprint, fulfilling beneficial social and environmental goals, it will make investors closely assess ESG and CSR factors in identifying their potential investments to have an impact investment. The diligence exercises carried out by investors will indeed have dedicated focus on ESG norms. As a corporate law legal advice, it is important for corporations and stakeholders to carefully assess the disclosures and compliances with ESG and CSR norms, in consultations with their advisors, including legal and financial.
*Co-authored by Manendra Singh, Associate Partner and Tanvi Goyal, Principal Associate of Economic Laws Practice
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