Expanding the scope of the Environmental, Social, and Governance (ESG) thematic category, the Securities and Exchange Board of India (SEBI) has allowed asset management companies to launch funds under six new strategies.

Currently, regulatory requirements permit mutual funds to launch only one scheme with ESG investing under the thematic category for equity schemes. However, in view of the increasing need for green financing, the capital markets regulator has now decided to permit the launch of multiple ESG schemes with different strategies by mutual funds.

ESG factor-based investing is catching up in all parts of the world, and Indian policymakers are also incentivizing sustainable investing.

New strategies

As per the SEBI circular dated July 20, any scheme under the ESG category can be launched with one of the following strategies – Exclusion, Integration, Best-in-class & Positive Screening, Impact investing, Sustainable objectives, and Transition or transition-related investments.

Explaining in detail, SEBI said that ‘Exclude’ securities will be based on certain ESG-related activities, business practices, or business segments. This strategy should specify the characteristic or type of exclusion such as adverse impact, controversy or Faith.

The ‘Integration’ themed funds would consider ESG-related factors that are material to the risk and return of the investment, alongside traditional financial factors, when making investment decisions.

Next, the ‘Best-in-class & Positive Screening’ strategy would aim to invest in companies and issuers that perform better than peers on one or more performance metrics related to ESG matters.

Next, ‘Impact’ investing would seek to generate a positive, measurable social or environmental impact alongside a financial return and how the fund manager intends to achieve the impact objective.

“Provide methodology used to assess the effect that investments have, or may have, on environmental or social or governance issues. Describe the process for identifying and avoiding, mitigating, or managing adverse effects that the scheme or underlying companies' activities have, or may have, on environmental or social issues. The fund should seek a non-financial (real world) impact and evaluate if that impact is being measured and monitored,” SEBI said for ‘Impact’ themed ESG funds.

The ‘Sustainable’ objective funds would invest in sectors, industries, or companies that are expected to benefit from long-term macro or structural ESG-related trends.

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Finally, the ‘Transition or Transition Related’ schemes would focus on companies and issuers that support/facilitate environmental transition and just transition.

Investment criteria

As per SEBI, a minimum of 80 percent of the total assets under management (AUM) of ESG schemes would need to be invested in equity instruments of that particular strategy of the scheme. Further, the remaining portion of the investment cannot be in contrast to the strategy of the scheme.

Presently, the ESG schemes are mandated to invest only in such companies which have comprehensive Business Responsibility and Sustainability Reporting (BRSR) disclosures.

BRSR or Business Responsibility and Sustainability Report requires listed companies in India to disclose information under the nine principles of the National Guidelines on Responsible Business Conduct.
The regulator has now decided that an ESG scheme will invest at least 65 percent of its AUM in companies which are reporting on comprehensive BRSR and are also providing assurance on BRSR Core disclosures

BRSR Core is expected to further increase transparency and ensure greater reliability of ESG disclosures.

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In terms of naming, mutual funds would be required to clearly disclose the name of the ESG strategy in the name of the concerned ESG fund/scheme. For eg., XYZ ESG Exclusionary Strategy Fund, ABC ESG Best-in-class Strategy Fund etc.

Back in focus

Back in 2020 when the coronavirus pandemic spread across the globe, a growing need was felt among investors to invest in ‘responsible’ companies. As a result, from just two ESG-based funds at the beginning of 2020, the number grew to 10 by the end of 2021.

SEBI’s thrust on ESG might just come as a blessing for ESG-specific MF schemes that started out with much promise during the coronavirus pandemic but have since failed to attract retail investors. Over the last few months, ESG funds have actually seen outflows.