Businesses are increasingly acknowledging the importance of integrating sustainability aspects and recognizing their impact on people, planet and profits. From an investor’s standpoint, ESG has emerged as a pivotal factor, not merely as an ethical consideration but as a strategic approach to identify resilient and forward-thinking businesses. ESG criteria play a crucial role in mitigating risks, aligning investments with values, and positioning portfolios for long-term success amidst evolving regulatory changes and geopolitical challenges.
To set the context, as of September 2023, there were over 5300 UNPRI (United Nations Principles of Responsible Investing) signatories, managing assets exceeding USD 121 trillion. The growth of asset owners, AUM, and signatories has demonstrated a robust 5-year CAGR, underscoring the widespread adoption of responsible investment practices.
In recent years, private market investors have rapidly embraced ESG management and impact investing, extending its application even to technology-driven businesses with a lean asset structure.
Envint has observed these trends in over 90 environmental and social due diligences (ESDD) conducted on portfolio companies,
amounting to aggregate investments surpassing USD 3 billion. Further, ESDDs have been conducted across a range of deal sizes from USD 1 million to – USD 120 million. Within the ESDDs, Envint has covered sectors such as BFSI, infrastructure, manufacturing, and services across a variety of sub-sectors like healthcare, renewable energy, agriculture, real estate, technology, automotive, waste, construction, textile, consumer, bio-CNG, green hydrogen.
Effectively Managing ESG Risks through Best Practices
The ESG risks in businesses primarily stem from legal non-compliance and absence or poor ESG management systems across a broad range of ESG themes including:
- Environment related: Life & fire safety, resource efficiency, environmental pollution
- Social related: DEI, labour & working conditions, occupational health & safety, community and customer health & safety.
- Governance related: Data privacy & information security, anti-corruption & anti-bribery, to name a few
Primary supply chain is also an important aspect that contributes to the ESG risk profile of a business.
- Compliance: The primary risk identified in due diligence assessments is the failure to adhere to established standards and regulations, particularly in the areas of environmental, labour, and safety standards. Shortcomings in legal compliance are evident in the absence of crucial documents and policies such as Shops & Establishment registration, accident insurance policy, building occupancy certificate, ESI & EPF payments, EPC license, and Pollution Control Board NOC. Occupational non-compliance encompasses issues like improper electrical safety, the presence of expired permits for vehicles/machines, and the lack of reflective signages/evacuation route maps. Additional compliance gaps pertain to labour law adherence. Proposed action plans involve instigating changes in the company’s HR and operations to ensure rigorous adherence to legal requirements and standards.
- Management Systems: Focused on administration, the Management Systems risk category addresses gaps identified in policy effectiveness, control and risk management, monitoring practices, grievance resolution, and organizational capacity. During due diligence processes, an examination of policies, reporting mechanisms, grievance handling, and overall organizational capability is carried out to identify potential risks. It’s noteworthy that these gaps, although often subtle, can have a significant impact, and suggestions for addressing them involve enhancing policy effectiveness, refining monitoring practices, and improving grievance resolution mechanisms.
- Life & fire safety: During reviews and site inspections, assessments are conducted on compliance with life and fire safety standards, uncovering shortcomings in employee and social safety, as well as product safety and public health. Gaps identified in life and fire safety encompass insufficient fire infrastructure, the lack of Emergency Preparedness and Response (EPRP) training, absence of mock drills, and the presence of expired or non- existent Fire No Objection Certificates (NOC). The focus is on strengthening safety protocols to rectify the identified gaps, as outlined in the observations and Environmental and Social (E&S) Action Plans.
- Occupational Health and Safety: Occupational Health and Safety hazards are more prevalent in labour-intensive sectors like infrastructure, agriculture, and real estate. Identified gaps in these areas encompass inadequate fall protection, absence of barricades on stairs, obstruction of emergency evacuation paths, improper use of personal protective equipment (PPE) for machinery/tools, electrocution hazards, electrical safety lapses, and concerns related to hygiene and food safety. Additionally, the presence of expired permits for vehicles and machinery amplifies these risks, categorizing them as high-risk factors due to the potential creation of unsafe working environments and the increased risk of injuries.
- Pollution Management: Risks associated with pollution management encompass the handling of hazardous materials and waste. Often, factory site inspections reveal improper storage of hazardous chemicals and inadequate disposal of biomedical or electronic waste. These deficiencies contribute to an unsafe working environment for employees. These risks are observed in various sectors including agriculture, healthcare, infrastructure, real estate, automobile, and other manufacturing industries.
- Working Conditions: · Working conditions address gaps related to labour in contractual employment. It’s frequently noted that there’s insufficient oversight concerning the payment of wages, Employee State Insurance (ESI), Employee Provident Fund (EPF), etc., for labour employees. Site visits additionally reveal poorly maintained labour camps.
- Primary Supply Chain: The Primary Supply Chain assumes a crucial role in today’s asset-light tech landscape, particularly for tech-based companies. A significant gap detected in the supply chain is the absence of established systems during the selection of third-party vendors, contract manufacturers, and outsourced labour. This lack of establishment results in inadequate oversight of Environmental and Social (E&S) aspects and the quality of the supply chain. Frequently, verbal agreements with third parties contribute to future gaps.
- Diversity, Equity & Inclusion: · The focus on Diversity, Equity and Inclusion (DEI) has intensified in the last 3 years. Key DEI risks include gaps in POSH policy or committee, where companies are often non-compliant by not including an external female member. Other identified gaps involve the absence of policies such as equal opportunity, collective bargaining, and retrenchment.
- Data Privacy & Information Security: Policies on Data Privacy and Information Security hold significant importance, especially for companies within the technology industry, as well as in the BFSI and NBFC sectors. The identified gaps are primarily associated with outdated or non-existent policies.
- Anti-corruption & Anti-bribery: The anti-corruption and anti-bribery policy serves to guarantee the legal compliance of a company’s business operations with external regulatory frameworks. The identified gaps are labelled by the absence of training or awareness programs on the code of conduct and anti-bribery-corruption, or even the complete absence of the policy itself.