NECESSITATING SUSTAINABILITY: EXPLORING THE REQUIREMENT OF ESG COMPLIANCE FOR MSMEs IN INDIA
Updated: Dec 26, 2022
This post is authored by Yash Sameer Joshi, a second-year B.B.A. LL.B student at the National Law University, Jodhpur & Krishna Ravishankar, a second-year B.A. LL.B student at the National Law University, Jodhpur.
With the conclusion of the COP-27 negotiations recently at Sharm-El-Sheikh, sustainability and mitigation through the “loss and damage fund” have come to the forefront. The permeation will be seen both by national governments and the private sector, with the focus shifting from “announcement” to “implementation”. India has set a loft target of achieving net zero by the year 2070 at the COP26 Conference. This ambition has been followed up by both Indian regulators as well as companies shifting from traditional regulatory mechanisms to more green and decarbonizing methods of environmental compliance and sustainability into their modus operandi. Environmental Social Governance (“ESG”) disclosures are one of the most significant parameters used by governmental agencies as well as the private sector as an archetypal measuring rod for the same in recent years. They primarily serve a three-tier purpose. For companies, they not only help in the minimization of transitional and financial risk as well as a reputational loss but also provide opportunities for innovation to self-assess their sustenance in the long term. For investors, it helps to determine the financial viability of a company determined by the socio-environmental impacts of its course of business. For consumers, it builds a stronger sense of trust and goodwill while engaging in those companies’ services. While ESG norms have been a buzzword among large corporate houses in India, its percolation to the Micro, Small, and Medium Enterprises (“MSME”) sector seems to be minimal. Before diagnosing the state of the problem pertaining to ESG disclosures to MSMEs, it is important to understand the trajectory of how ESG has evolved in India.
2. EVOLUTION OF ESG NORMS IN INDIA
The genesis of ESG norms can be traced to the National Voluntary Guidelines (“NGVs”) issued by the Ministry of Corporate Affairs in 2009 followed by the SEBI mandate of 2012 of the top listed 100 businesses to declare their NGVs along with their business statements as per the Business Responsibility Report of 2008. Section 134(m) of the Companies Act, 2013 read with Rule 8(3)(A) of Companies Account Rules, 2014, which places a mandatory obligation on the board of directors to provide information on energy usage and conversation, along with the Corporate Social Responsibility Rules, 2014 are two other avenues of the Indian ESG framework. In 2017, the SEBI Circular on Disclosure Requirements for Issuance and Listing of Green Debt Securities in order to regulate green debt securities included additional parameters for financing ESG-Complaint Projects related to subject matters like renewable energy, sustainable land use, and biodiversity conversation. Another milestone in the nascent Indian ESG framework is the establishment of the Business Responsibility and Sustainability Report (“BRSR”) from FY 2022-2023 which replaces the Business Responsibility Reporting (“BRR”) framework through the amendment of the SEBI (Listing Obligation and Disclosure Requirements) Regulation, 2015 making it mandatory for the top-listed 1000 companies to make ESG-related disclosures at the end of every financial year. The BRSR regulations were issued in alignment with the Ministry of Corporate Affair’s National Guidelines for Responsible Business Conduct (“NGBRC”) issued in 2019 which eventually will lead to the formation of a BRSR Index. These ESG norms have been affirmed and elaborated by various official sources such as the SEBI Consultation Paper on ESG Rating Providers and the RBI Report of the Survey on Climate Risk and Sustainable Finance. Further, while there has been no direct judgement laying down ESG norms, the Supreme Court has very clearly affirmed that environmental protection is something that company directors have to strive for and implement.
3. THE BRSR MISSES VIZ-A-VIZ THE MSME SECTOR
The BRSR evolves an important ESG reporting and compliance mechanism in India. It provides for a two-pronged disclosure : mandatory as well as voluntary disclosures which provide an impetus for many companies to assess the disclosure threshold based on their market-specific domains making it surely a step in the right direction. These disclosures can broadly be divided into three categories: General Disclosures, Management and Process Disclosures, and Principle Wise Performance Disclosures. Some relevant particulars of these broad categories include aspects relating to products and services provided by the business, Corporate Social Responsibility details, transparency and disclosure guidelines based on the NGV’s structures and policies adopted towards complying with the NGRBCs, etc.
Examining it from the light of Micro, Small, and Medium Enterprises does not paint a pleasant picture. First classified and defined statutorily under Section 7 of the MSME Development Act of 2006, MSMEs constitute more than 90% of Indian businesses providing employment to more than 45% of the populace and contribute to more than 30% of real Indian GDP. Thus, MSMEs play a pivotal role in determining the course of Indian business and its impact on ecological and environmental footprints. Examining the current BRSR framework, it provides for an ESG compliance scheme only for the top 1000 listed companies based on market capitalization which merely constitute the top 1% of the Indian Business Ecosystem excluding the majority of businesses. According to the NITI Aayog’s Expert Group on Climate Change, industries and businesses, in general, constitute one-fourth of the carbon footprint of India. According to a joint study conducted by the Small Industries Development Bank of India and GIZ of Germany, this carbon footprint is largely attributed to the MSME sector which occurs due to a lack of resources for environmental compliance and the use of outdated technology. Thus, there is a dire need to bring MSMEs under the fold of an ESG regulatory framework.
However, there are some inherent flaws in the current BRSR framework when it comes to ease of compliance for MSMEs. Firstly, since this audit of ESG Reporting is more of an internal one and under the BRSR companies do not mandate these audits to be conducted by external or third-party independent agencies, investors fear that with self-reporting mechanisms there could be “greenwashing” wherein companies provide unverified ESG reports. Secondly, there is also a general lack of awareness and apprehension of higher due diligence costs with regard to ESG compliance.
4. STATE OF THE PROBLEM AND SUGGESTIONS
Despite the inherent need for ESG compliance, the fact that ESG reporting for MSMEs may not be financially feasible cannot be ignored, especially where the reporting framework is relatively comprehensive (BRSRs). So, the question that is bound to arise is how to solve the affordability and necessity conundrum. The answer to this can be sought by looking both at the past and present of ESG reporting in India. The first step of action that can be initiated is making BRSR lite compulsory for all listed companies including MSMEs, excluding the top 1000 listed companies which already have their disclosure standards, as we have already explored above. Some disclosure aspects of the BRSR Lite that set it apart from the normal BRSR guidelines include but are not limited to the fact that disclosure of “leadership indicators” under Principle wise performance disclosures is non-mandatory, easing the process for smaller companies. A more comprehensive layout of the Lite framework has been aptly provided by the Ministry of Corporate Affairs.
The provisions of BRSR Lite may still seem too broad for MSMEs, as some of the more onerous requirements include listing the “top 3 plants”. In such a situation, it seems that a “Lite” or more aptly a smaller-scale version of the current BRSR Lite disclosure standards is required for MSMEs. This may have the same parameters or similar parameters as are there in the Lite model, just on a smaller scale and more curated to the so-called ‘little guys’.
According to the authors, this would be a suitable course of action in light of the European Experience via Directive 2021/0104, which elucidated that voluntary disclosures of ESG-based parameters among MSMEs always lead to skewed implementation. In a situation where the MSMEs will still not be able to abide by these standards, the so-called ‘checklist version’ that was followed in the previous BRR format should be taken up, which was less data-intensive as compared to the BRSR formats and followed the preliminary NGV model. A contention may arise that this would defeat the entire point of adding the more comprehensive BRSR. However, we have to keep in mind that these recommendations are not for the top 1000 listed companies, but rather MSMEs lower on the capital and individual social impact echelons. The prime purpose of taking this step would be to ensure that even smaller enterprises get initial exposure to ESG reporting, considering the importance that is going to be accrued with said reporting in the not-so-distant future. Once ESG reporting becomes a norm among MSMEs, the next step would be to establish credible agencies through a public-private partnership model involving the expertise of the private sector and the financial assistance of the Government to conduct impartial and independent ESG Compliance Audits to avoid problems of Green Washing arising of Self-Reporting to boost the investing credentials of the MSMEs among potential investors.
Now that a working model has been suggested, it is important to look into its implementation. As stated in the report of the 2015 Addis Ababa Action Agenda of the UNICTRAL Working Group on SMEs, one of the major reasons for non-implementation is a lack of awareness and appetite among the MSMEs regarding the long-run benefits of ESG compliance. Further, a report by report by the International Chamber of Commerce titled ‘Scaling MSME Sustainability Reporting’ clearly indicates that MSMEs are either averse to ESG disclosure regulation or unaware of what framework they should choose for the same. Thus, it is incumbent upon national governments to create awareness as well as the climate for ESG compliance. Financial resource restraints are one of the biggest impediments MSMEs face in India and thus linking credit provision incentives to ESG compliance will ensure better implementation. One such incentive can be seen through the Green Finance Initiative of the Reserve Bank of India which looks at supplying credit through Sustainability Linked Loans which consider the sustainability performance of the MSME before any credit is granted, which will allow MSMEs to adopt greener technologies in their course of business. Another working model that India could implement is the EU Directive 2019/2088 that banks, investors, and other financial institutions are required to report on “their approach in evaluating ESG efforts spent by investee companies and the associated risks, including the supply of finance.” Thus, shifting the burden of potential investors to do their due diligence before investing in an MSME. This would also be an incentive for the company itself, or more aptly a deterrent from not partaking in proper ESG reporting.
Increased globalization and a general lean by investors, both foreign and domestic, towards sustainable and socially responsible companies would make it unwise and impractical to keep the lifelines of the Indian economy out of the ESG loop. While a complete transition into full-fledged reporting will be and should be, a drawn-out and well-planned process, it is prudent that we introduce the concept of ESG reporting to listed MSMEs in a comparatively sprightly manner. Problems such as financial limitations and greenwashing are bound to arise, and a plan of action has to be developed for the same as has been suggested in the blog, but the implementation of compulsory ESG reporting would be a step in the right direction. With the words “sustainable” and “green” on everyone’s lips in this era of development, vying for ESG reporting in the professional Indian business model seems to be the need of the hour.