The importance of Governance in ESG paradigm

G in ESG remains critical to ensure the success of the entire ESG concept as a fundamental

Dr Megha Jain and Dr Palakh Jain | April 13, 2023


#Society   #Environment   #Business   #Governance   #Finance  
(Illustration: Ashish Asthana)
(Illustration: Ashish Asthana)

The journey of ESG is a bridge from ‘qualitative change’ to a ‘measurable value’. ESG is the consideration of E-S-and-G non-financial issues, alongside financial factors, where E stands for Environmental; S for Social, and G for Governance. Simply put, ESG is a set of parameters that financiers may refer to while screening a counterparty on desirable characteristics, gauge the non-financial risks it may face that are mostly uncertain and non-linear in nature but might negatively impact the financial position of the counterparty, and hence its financials.

Now, ESG is much more than just good intentions or proverbs used. It’s about converting and implementing into the tangible, applied governance real action. The number of stakeholders has multiplied in the ESG space given the fiduciary role of banks and financial institutions. This is something financial institutions cannot ignore.

Today, the communities of environmentalists, sociologists, economists, strategists and technologists all put a key emphasis on the relevance of the G component of the ESG factors impacting different streams. By assigning weightage to governance as a parameter, management in a typical organisation has started converting the theory of good governance practices into action. The World Bank ‘Worldwide Governance Indicators’ (WGI) scores aggregate and individual governance indicators for over 200 nations on six broad dimensions – Voice & Accountability, Regulatory Quality, Rule of Law, Government Effectiveness, Control of Corruption, and Political Stability & Absence of Violence.

Countries rated high on governance parameter, in general, command better creditworthiness and say internationally. Over a while, there is a dynamic shift in the trend that is witnessed worldwide from a qualitative understanding of governance under the ESG pillars to applied best practices to benchmark and mandate competitive advantage globally. Several studies have shown that the success of the ESG storyline shall be contingent upon how well the governance pillar would be embedded in the broader principles of climate sustainability, sustainable investments and disclosures.

Given the recent events of turmoil based upon ESG being declared as a scam by people like Elon Musk or another way towards greenwashing, the governance pillar’s role has become even more vital. Governance under ESG was initially understood as the collection of rules, best practices and a certain collection of processes on the governance of an organisation. Now, due to the ‘G’ component, ESG is no more a moral crusade. There are tools and a whole gamut of techniques that are quite useful to conduct assessment and supervision of ESG penetration in an organisation. ESG is the first step when an investor is particularly moving towards green finance activities. And governance makes it effective by evaluating the overall assessment. The G factor gives a way to regulate ESG research and reach wider. ESG ratings have a deep impact on company-specific, industry-related and economy-wide parameters.

Internationally, several organisations have made ESG reporting mandatory. With initial disregard to the G pillar of ESG, the governance parameter can and has laid the foundation for long-term value generation and entails the success storyboard for the E and S pillars of ESG. Due to G being directly associated with the management and board of the companies, even banks and FIs’ recent Basel III reforms puts greater stress on the supervisory role of management under the G pillar.

To summarise, G in ESG remains critical to ensure the success of the entire ESG concept as a fundamental. Additionally, the concept of stakeholder capitalism could prove instrumental for uplifting financial performance, simply by scaling the governance practices. It certainly proves an added advantage for boosting the investors’ confidence by just ensuring good governing practices. Diversity in the boardroom, compliance, creating and executing policy, compensation for executives and several spots on the board of executives – all need to be measured under the G pillar to put the same into practice. It is often said, “Enabling to tackle the biggest challenges of today helps capture the best opportunities of tomorrow.”

Dr Megha Jain is an independent researcher/ faculty, University of Delhi. Dr Palakh Jain is Associate Professor, Bennett University, Noida, and Senior Visiting Fellow, Pahle India Foundation.

 

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