LIC seeks ESG ranking ahead of IPO — Will it set a precedent?

10 Feb 2022 , 12:49 PM

Upcoming mega IPO of India’s life insurance behemoth, LIC manages to remain in the limelight consistently. This is because of the multitude of steps taken by the government ahead of the listing. The IPO will enable the government to push ahead its disinvestment agenda which has been missing the mark, year after year.

The recent development in LIC’s IPO saga is that the government is looking to get an ESG (Environment, Social and Governance) score for the country’s largest life insurer before tapping into the capital markets. This development stands out for the single reason that it’s the first time (in India) a company about to list has sought an ESG score. It underlines the rising emphasis placed by investors on ESG performance of a company. ESG investing has gathered increased momentum in the post pandemic world. In simple terms, ESG investing assesses the sustainability and societal impact of an investment in a company or a business. The purpose of ESG investing is same as traditional investing — to generate alpha or positive returns by investing in good companies. However, under ESG investing, investors look beyond the economic performance of a company and focus on the holistic value it creates for all stakeholders. Typically, stakeholders of a company include employees, customers, business partners, lenders, regulators, communities and the society at large.

Coming back to LIC, recent development gives rise to several questions. What is the role of an ESG score in ESG investing? Will LIC set a precedent for other IPO-bound companies? How can companies get favorable ESG score?

What is the role of an ESG score in ESG investing?

An ESG score rates the company on the basis of its ESG performance. Medium-to-long-term risks associated with E, S and G aspects such as a company’s environment footprint, employee/customer related practices, community initiatives and governance practices are identified and the impact (both financial and non-financial) of these are measured.

Environmental Analyses the impact of a company’s business activities on the environment.   Answers questions such as   Is the company using natural resources such as water, energy responsibly?   Is it reducing carbon emissions from its operations?   Is it keeping a check on generation and disposal of solid and e-wastes?

KPIs tracked Carbon emissions Energy conservation Water conservation Climate change Creation and disposal of wastes Sustainable products

Social Considers the company’s business relationships.   These include its customers, society, employees, supply chain partners and regulators.

KPIs tracked Contribution to social causes Employee welfare, health and safety Human rights Equal opportunity and diversity Sustainable supply chain Customers Interests of all stakeholders

Governance Focuses on the corporate governance practices of a company.

KPIs tracked Clean accounting Regulatory compliance Ethical, fair and transparent business conduct Interest of minority stakeholders

These scores are provided by companies such as MSCI, Sustainalytics, rating agencies, among others. These companies have their own methodologies and criteria to arrive at the ESG score of a company.  Domestic and foreign institutional investors then use these ESG scores along with their own fundamental analysis to identify high quality companies. Often, these investors and ESG ranking companies, as a rule, exclude companies in the business of tobacco, alcohol, weapons, gambling and such relatively less socially responsible activities.

Will LIC set a precedent for other IPO-bound companies?

This possibility cannot be ruled out given the exponential surge in ESG investing, not just in India, but also globally. A quick glance at the numbers tells the complete story. The Assets Under Management (AUM) of ESG-based funds has risen 4.7x in two years to over Rs. 12,300 crore from Rs. 2,630 crore in November 2019 (source: Business Standard). Data from Refinitiv Lipper data suggests that funds worth $649 billion flowed into ESG-focused funds worldwide through November 2021, up from inflows worth $542 billion and $285 billion into these funds in 2020 and 2019, respectively. ESG funds form 10% of worldwide fund assets. This metric stands at a miniscule fraction i.e. 0.3% of total AUM of Indian mutual funds.

Experts believe, over the medium term, ESG parameters will form an integral part of all lending and investment decisions. Regulators too have been taking several measures to push India Inc. to adopt superior ESG practices and align them with global standards. At the same time, regulators are framing guidelines to regulate ESG investing by mutual funds, ESG rating done by agencies and so on.

How can companies get favorable ESG score?

ESG scores are based on the actual ESG initiatives implemented by a company and the scale of impact of these initiatives. LIC, for instance, has been in business since 1956 and has a vast reach in terms of employees (over 1 lakh), agent network (10 lakh+) and physical branches. It has the scale to make a meaningful impact within its communities. Country’s largest life insurer’s community initiatives are aimed at developing the infrastructure and social sector (as per its FY21 annual report). Likewise, it has several people practices to provide them with training, development and other facilities. We await more details on the initiatives taken by LIC to reduce its environment footprint.

In short, it takes years for any entity to initiate its ESG strategy, integrate the same within its operations and make a real, sizeable impact on its stakeholders. Most large Indian companies (listed and unlisted) have a strong focus on the ‘S’ i.e. social aspect given the country’s inherent culture of ‘giving’ and working towards the greater good. With rising investor awareness and activism around governance, a lot of Indian companies have upped the standard of their corporate governance practices in recent times (though a lot needs to be done yet). On the environment front too, several large and mid-size companies, particularly in the manufacturing sector have clearly defined the roadmap to become net zero over the next 3-5 years. Large companies in service-oriented sectors (IT, BFSI, etc.) are also working proactively to reduce their environment footprint.

Conclusion

In its essence, ESG investing goes way beyond just a tick-marking exercise. There is no quick fix to get a favorable ESG score and attract capital from investors focused on socially responsible businesses. Amid rising scrutiny of investors, consumers, regulators and other key stakeholders; it is imperative for corporates to ‘walk the talk’ on ESG. Those who do so will create a sustainable, long-term economic moat; while the rest are most likely to fall on the sidelines. 

The author of this article is Sheetal Agarwal, AVP-Content and Communications, IIFL Group