ESG regulations typically encompass regulatory measures designed to promote sustainable and responsible business practices. However, the regulatory framework for the same in India is found to be a patchwork of clauses in various pieces of legislation like the Factories Act 1948, the Companies Act 2013, Water (Prevention and Control of Pollution) Act 2016, Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations 2015, Prevention of Money Laundering Act 2002, etc.[1] Furthermore, this heavily unorganized regime is accompanied by the dual existence of CSR (Corporate social responsibility) and ESG in the legal consciousness of the Indian legal regime with the latter gaining more prominence in recent times.[2]
In such a situation applying this framework to the Indian start-up ecosystem (third largest in the world with over a 100,000 registered) raises several questions as to: (1) how does this affect their competitiveness in the market, (2) what legal intricacies will it be subject to and (3) finally, what new opportunities does it present and how to adapt to the challenges.
Understanding ESG in the Indian context
In order to answer the questions mentioned above, it is imperative to contextualize what the ESG regime in India encompasses. Unlike the UK and other commonwealth nations where the ESG framework works on the principle of achieving sustainable development while keeping profit and market driven considerations of shareholders’ interest primary to others, Indian corporate law followed a more pluralist approach.[3] This effectively translated into multiple stakeholders like creditors, employees, the environment, society, etc. being given equal importance to harmonize the company’s material growth targets with the multiple and novel concerns arising for each stakeholder in the Indian legal and societal context.[4]
Moreover, the idea of ‘public interest’ found a place in the then prevalent Companies Act 1956, which signifies the expansion of corporate law from merely considering private interests to one that broadens the horizons to incorporate the societal impact of a company’s activities.[5] This gave rise to a varying model of ESG framework, which unlike the financial model of the UK, was called the entity model.
This had a profound impact on the development of the three important components of ESG in India, i.e., (1) Directors’ duties, (2) ESG reporting and (3) shareholder stewardship codes.[6]
Contextualizing components of ESG for Startups
Firstly, Section 166(2) of the Companies Act 2013 defines:
A director of a company shall 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 the company, its employees, the shareholders, community and for the protection of environment.[7]
Specifically in case of start-ups, their primary concerns often with ESG is balancing survival and growth along with the former. This entails huge financial and other hidden costs when undertaking these activities (e.g. detailed audits, trying to control their carbon footprint, etc.) worsened by the prospect of lack of standards of reporting or universal framework.[8]
Secondly, as previously stated, the lack of standards tailored specifically keeping in mind, the nascent stage of the startup ecosystem’s development in India as opposed to their foreign counterparts or even large conglomerates, it creates a lot of confusion as to which standards they should specifically look up to. Even the ones already existent like the Business Responsibility and Sustainability Reporting (BRSR) framework in India, or the global ones like the Global Reporting Initiative framework (GRI), are devoid of startup-friendly provisions.
Finally, the existing regulatory landscape of the stewardship codes in India is heavily internalized as per the preferences of the venture capitalists and other investors of these firms, thus effectively having a shareholder-driven ESG model as opposed to the director’s functions as defined earlier.
Thus, in the end, four main challenges emerge for the startups:
(i) Navigating through these conflicting notions of different components of ESG, they need to be able to develop effective and sustainable business models in order to be able to balance out the dual obligations of shareholder wealth maximisation and satisfaction of the other constituencies.
(ii) This becomes additionally important because as the awareness and knowledge of environmental damage increases, so will the integration of the ESG criteria into the financial and banking system of the country. Hence, this would additionally, give rise to a class of environment conscious investors preferring startups with a better ESG rating and compliance.
(iii) The same goes for availing funding from the public sector as well as its various subsidies and schemes. For example, the SIDBI Fund of Funds launched a Green Finance Scheme for MSMEs covering sectors such as Renewable, Transport, Waste and Energy which has integrated ESG parameters.[9]
(iv) Finally, building the organizational structure and values as such that are accommodative of a harmonious integration of various stakeholders with regards to ESG and wealth creation, with the increasing prominence of stakeholders’ views and importance in the organization necessitating more transparency and accountability, becomes a key concern for continued survival.
Potential opportunities in face of challenges
In order, to achieve perfect harmonization of the stakeholders and the company’s goals, the following framework could be followed by the founders:
- Focusing on the basics:
The basic proposition for a startup being finding the right market fit and earning profits can be done in a holistic manner by maintaining a steady feedback loop from employees, shareholders, customers, etc; in order to formulate ESG policies effectively cementing them into the company structure.
- Define a purpose:
The purpose or the problem statement which the company aims to solve can be an effective way to harness the potential of the ESG-based startup opportunities. For instance, the Indian Government’s recent push for various sectors like renewable energy, clean technology, EVs, Education technology, healthcare, financial inclusion through revolutionary fintech solutions, Legal technology, cybersecurity and even many ESG-compliance technology solutions have been instrumental in birth of many successful new-age startups.
- Emphasize culture:
The policies which shape the corporate culture in a company, are key to attract and retain skilled employees and new talent. Even startups not significantly able to add value to the ‘E’ or environment aspect, can still significantly boost its social and governance performance by creating a vibrant and accommodative corporate culture, having greater efficiency and effectiveness in meeting their targets while addressing the issue of human rights, safe workspace for women, room for innovation and employee enrichment, etc.
- Focus on Risk Management:
The ESG regime is a dynamic and fast evolving space having the potential to disrupt many existing sectors, business models and organizations. Taking the ESG factors into considerations and predictions for future risks and opportunities can go a long way in effective decision-making both in terms of allocation of resources for various functions, as well as preparing for any potential disruptions.
Potential future issues
As ESG awareness rises so will call for action on the following issues:
1. Climate change: Curbing CO2 emissions, limiting pollution, etc; have been a major issue, with the one of the end goals of ESG frameworks being to become carbon neutral and further.[10]
2. Human Rights: Making sure adherence to various legislations against forced labour and child labour in the supply chain networks of these startups, in addition to the POSH Act 2013, etc. will become prominent.[11]
3. Cybersecurity: With rise in new-age technologies, Artificial Intelligence, and democratization of data, cybersecurity will be evolving into a major issue of concern owing to the significant number of data leaks in major corporations like Meta, etc; even as recently on the Dark Web warrant care and precaution in this regard.[12]
4. Bribery/Corruption: Money laundering, frauds, misrepresentation of accounts, and in the latest greenwashing, tax evasion non-compliance with disclosure mechanisms, etc. need to be taken into cognisance as ESG becomes more prominent.[13]
Conclusion
While there are many challenges present, as to absence of a common taxonomy and framework for regulating the dynamic ESG space for the startup ecosystem, the same uncertainty presents a variety of opportunities for betterment of governance and enhancement of the system as a whole if harnessed properly.
[1] See ICLG.com, https://iclg.com/practice-areas/environmental-social-and-governance-law/india (last visited Jan. 24, 2024).
[2] See Umakanth Varottil, The Legal and Regulatory Impetus Towards ESG in India: Developments and Challenges, NUS Law J. 1, 4 (2023).
[3] Id. at 4
[4] Id.
[5] Umakanth Varottil, The Stakeholder Approach to Corporate Law: A Historical Perspective from India, RESEARCH HANDBOOK ON THE HISTORY OF CORPORATE AND COMPANY LAW 381, 386–387 (Harwell Wells ed., 2018).
[6] See Umakanth Varottil, The Legal and Regulatory Impetus Towards ESG in India: Developments and Challenges, NUS Law J. 1, 5 (2023).
[7] The Companies Act, 2013, § 166(2), No.18, (India)
[8] See Celina Gandhi and Anuradha Gandhi, Decoding ESG for Startups, S.S. Rana & Co. (Nov 29, 2023), https://ssrana.in/articles/decoding-esg-for-startups/
[9] Celina Gandhi and Anuradha Gandhi, Decoding ESG for Startups, S.S. Rana & Co. (Nov 29, 2023), https://ssrana.in/articles/decoding-esg-for-startups/
[10] See Nitish Desia Associates, https://nishithdesai.com/fileadmin/user_upload/pdfs/Research_Papers/ESG-The-New-Age-Value-Creator.pdf (last visited Jan 22, 2024)
[11] Id. at 14
[12] Id. at 14
[13] Id. at 16
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