India Strategy | Get on track please !
Thematic | June 2017
Sustainability
NEW MANTRA OF INTEGRATED INVESTING
S
E
G
Expanding horizons
Sandeep Gupta (S.Gupta@MotilalOswal.com); +91 22 3982 5544
Lopa Thakkar (Lopa.Thakkar@MotilalOswal.com); +9122 3027 8029
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Thematic | Expanding Horizons
Contents | Sustainability: Expanding horizons
Summary ............................................................................................................................... 3
A Historic Metamorphosis – Evolution of Sustainability ........................................................ 6
Integrating ESG – Critical for Investment Sustainability ......................................................... 8
Concerns about impending environmental risk ........................................................ 10
Social risk can cause serious disruptions in operations ............................................. 13
Governance – paramount from investment perspective........................................... 16
ESG – Making investors wealthy globally ............................................................................ 20
India is ESG-positive, but at a nascent stage ........................................................................ 25
June 2017
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Sustainability | TheExpanding Horizons
Thematic | Goose Barometer
Sustainability
Expanding horizons
Applying sustainability metrics to investment decisions
Investors are increasingly integrating ‘sustainability’ into their investment
decisions. Global sustainable and responsible investment (SRI) assets have
grown at a CAGR (FY12-16) of 15% to reach USD23t, accounting for 26% of
total professionally managed assets.
What began as a risk management tool – measured in terms of environment,
social, and governance (ESG) parameters – has also proved to be a sound
investment strategy. The S&P 500 ESG Index has outperformed the S&P 500 by
500bp over the past seven years. In emerging markets, the MSCI EM ESG Index
has outperformed the MSCI EM Index by over 4,500bp.
In India, sustainable investing is at a nascent stage; however, 62% of the Nifty
50 companies voluntarily release their sustainability reports. Against this
backdrop, we believe that SRI-based investing in India should pick up over the
medium term.
Our analysis based on ESG materiality matrix-centered KPI highlights that in
the Indian context, companies in cement, oil and gas, power and metals are
more exposed to sustainability-related risks, while those in banks, IT, and
FMCG sectors are relatively well placed.
Evolving trend of integrating sustainability in investing
Sustainability
Expanding horizons
Success of a business depends on multiple forms of capital, such as human
capital, intellectual capital, natural capital and financial capital. However,
historically, investors have measured returns based only on financial capital.
However, more recently, there has been an increasing investor focus toward
‘sustainability,’ an evolving risk management tool that seeks to integrate regular
financial aspects with E, S, and G criteria to obtain a holistic view of a company’s
performance.
The “E” –
Environment
criterion looks at how a company performs with
respect to its natural capital.
The “S” –
Social
criterion examines how a company manages its
relationships with employees, customers and communities.
The “G” –
Corporate Governance
criterion evaluates rules, practices and
processes by which a company is directed and controlled, essentially
involving balancing the interests of all stakeholders.
+91 22 3982 5544
S.Gupta@MotilalOswal.com
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Sustainability is evolving globally; India is ESG-positive, but at nascent stage
Over last four years, sustainable investing has increased globally in both
absolute and relative terms. Global SRI assets exhibited a CAGR (CY12-16) of
15% to reach USD23t (26% of professionally managed assets), outpacing growth
of total professionally managed assets (CAGR of 9% to USD87t).
Europe and the US, the two major global investment hubs, account for 53% and
22%, respectively, of the total global SRI assets.
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Thematic | Expanding Horizons
In India, sustainable investing is at a nascent stage. We believe that with rising
investor interest, SRI is likely to pick up in India over the medium term.
The significance of integrating sustainability analysis is reinstated when we look
at the recent case of BHEL. In May 2017, Norway’s USD940b sovereign wealth
fund reported that it had excluded BHEL from its portfolio on environmental
grounds.
Sustainability risk is divergent across sectors
Our analysis of sustainability-based ESG parameters highlights that the
materiality varies across sectors and is primarily dependent on the nature of the
business and the country in which it operates. Also, within each sector,
company-level performance is dependent on efforts taken by the company to
mitigate risks.
We believe that manufacturing sectors are more prone to the environment and
social risks. On the other hand, the services sector, which largely involves
human capital, is more exposed to the social risk. Governance risk
predominantly applies almost evenly across sectors.
A few challenges remain in fully integrating ESG
With the rising investor focus, many companies have started releasing their
sustainability reports. However, due to the lack of globally accepted standards,
data disclosed are not standardized across companies in multiple sectors.
Also, since quantifying the sustainability risk is challenging, at times, it may be
difficult to assess the valuation impact until the event has actually happened.
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Thematic | Expanding Horizons
Indian context - Materiality of ESG measures varies across sectors
Cement Capital
goods
Auto
Banks Telecom Pharma
IT
FMCG
Oil & Metals
Gas
Power
Environment
CO2 emissions
Toxic emissions
Waste disposal
Opportunities in renewable
sources of energy
Opportunities in clean technology
Energy conservation/efficiency
Financing environmental impact
Biodiversity and land use
Water conservation
Product emissions
Source: MOSL
Social
Industrial Relations
Attrition
Diversity at workplace
Training and skill development
Health & Safety
Corruption/Marketing malpractices
Privacy and data security
Product safety
Customer satisfaction
Providing access to healthcare
Providing access to finance
Providing access to communication
Governance
Related party transactions
Alignment of interests
Accounting practices
Executive Compensation
Board Independence
Rotation of independent directors
Rotation of auditors
Board members attendance
Product profile concentration
Geographical concentration
Customer concentration
Vendor concentration
Regulatory risk
Investment in technology/ R&D
Execution and financial risk
Note: The above matrix is indicative and not exhaustive
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Thematic | Expanding Horizons
A Historic Metamorphosis – Evolution of Sustainability
The concept of integrated investing has been evolving over time. So far, investors
were keenly looking at companies’ earnings growth to gauge the return prospects. The
increasing focus on quality of earnings (QoE) brings rationalization to future estimates
and correspondingly the present value of stocks.
Meanwhile, the need for corporate governance too gained prominence to balance
stakeholder interests. The Clause 49 of the listing agreement made corporate
governance practices mandatory for all listed entities. Thus Institutional investors
migrated to a more rounded approach toward investing, factoring in QoE and
corporate governance practices.
Notably, the western world has evolved further to integrate a more comprehensive
and far-reaching tool in investing – sustainability – which is measured from an
environment, social and governance perspective.
ESG is the catch-all term for integrated investing. It is a risk management tool that
seeks to integrate regular financial aspects with Environment (E), Social (S) and
Governance (G) criteria.
ESG has been evolving over time; it completes the story on integrated investing
EARNINGS
QUALITY OF
EARNINGS
CORPORATE
GOVERNANCE
ESG (ENVIRONMENT,
SOCIAL, GOVERNANCE)
QoE brings rationalization to earnings estimates
QoE denotes the degree to
which earnings growth of a
company is sustainable. It
considers earnings
generated from the core
business activities
Investors have been keenly looking at companies’ earnings growth to gauge the
return prospects. Evidently, every percentage point increase in earnings brings
cheer in the markets. So long as the accretion to earnings is sustainable, it is
only positive. Therefore, a new focus area – quality of earnings (QoE) – has
emerged as investors began to emphasize on the sustainability of earnings.
QoE denotes the degree to which earnings growth of a company is sustainable.
It considers earnings generated from the core business activities (generally due
to higher growth in the business, increasing efficiencies, etc.). In other words, it
seeks to exclude any non-core, non-recurring income/expenses to determine
the real value generated from the core business.
The increasing focus on QoE brings rationalization to future estimates and thus
the present value of the stock.
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June 2017

Thematic | Expanding Horizons
Corporate governance framework balances stakeholder interests
Corporate governance and
QoE together provided a
more rounded approach to
investing
Corporate governance in India gained prominence following the economic
liberalization in 1990s. By 2000, it went from being a voluntary activity to
becoming a compulsory requirement backed by laws. However, it turned back to
a voluntary activity in 2009 and again became mandatory in 2014 as prescribed
by the revised Clause 49.
Corporate governance is a soft issue, whose essence cannot be captured by
quantitative factors. However, we note that good corporate governance is the
backbone for balancing stakeholder interests.
Therefore, the focus migrated to a more holistic investment approach, factoring
in QoE and corporate governance practices.
This ensured that money flowed into sustainable and quality businesses, where
established frameworks for attaining company objectives are predetermined
and stakeholder interests are balanced.
Corporate governance measures made mandatory; ESG likely to follow
VOLUNTARY
MANDATORY
VOLUNTARY
MANDATORY
1990
Introduced as a
voluntary
measure by the
Confederation of
Indian Industry
(CII)
2000
Introduced in the
Clause 49 of the
Listing Agreement
for companies of a
certain size
2009
Ministry of
Corporate Affairs
(MCA) released
voluntary
guidelines
2014
Mandated in the
revised Clause 49
of the listing
agreement
Source: MOSL, Media articles, Report - Study on state of corporate governance in India by IICA, Thought Arbitrage and IIM-C
ESG is the catch-all term for integrated investing
The environment criterion
looks at how a company
performs with respect to its
natural capital
The western world has further evolved to integrate sustainability as another
important criterion to evaluate investments.
Sustainability is a risk management tool that looks at businesses from an
environment, social and corporate governance perspective. It seeks to integrate
regular financial aspects with E, S, and G criteria to obtain a holistic view.
The
“E”
– environment criterion looks at how a company performs with
respect to its natural capital.
The
“S”
– social criterion examines how a company manages its
relationships with employees, customers and communities.
The
“G”
– corporate governance criterion evaluates rules, practices and
processes by which a company is directed and controlled. Corporate
governance essentially involves balancing the interests of all stakeholders
(e.g., shareholders, management, customers, suppliers, financiers and the
government).
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Thematic | Expanding Horizons
Integrating ESG – Critical for Investment Sustainability
ESG is a risk management tool that manages exposures related to environment, social
and governance risk.
ESG metrics have been strong indicators of future volatility and earnings risks – it is
not just a hygiene factor.
Overlooking ESG issues has resulted in some of the largest fines and settlements,
externalities such as unpriced natural capital assets, and hindrances in the form of
operational/reputational risk.
ESG metrics thus are strong
indicators of future
volatility and earnings risk
ESG - The new risk barometer
Known risks can be weighed against known benefits; however, unknown risks
cannot be factored in for any potential benefits/losses. Therefore, integrating
ESG is important as it is a new source of identifying underlying risks associated
with E, S, and G metrics.
To corroborate the importance of ESG in investment decisions, consider the
recent situation in Aurangabad, where breweries such as Carlsberg and
SABMiller had to shut down plants entirely in May 2016 due to water shortage.
ESG metrics thus are strong indicators of future volatility and earnings risk. ESG
integration is important, as picking future winners requires identifying hidden
risks that can have a substantial impact on stock price movement.
Exhibit 1: Reasons for integrating ESG in investment decisions
Indicators of
future
volatility and
earnings risk
Identifying
hidden risks
Risk of fines
and
settlements
Achieve
value based
goals
Threat of
climate
change
Depletion of
resources
Source: MOSL
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Thematic | Expanding Horizons
Avoiding ESG can result losses of millions of dollars
Success of a business
depends on multiple forms
of capital, such as human
capital, intellectual capital,
natural capital and financial
capital
Success of a business depends on multiple forms of capital, such as human
capital, intellectual capital, natural capital and financial capital. However,
investors mostly measure the returns prospects based only on financial capital.
Thus, this system seems to be intuitively faulty.
Overlooking ESG issues can result in some of the largest fines and settlements
(refer exhibit 2). Also, externalities such as unpriced natural capital assets
(comprising climate, soil and biodiversity) are severely affected. This brings us to
a key question: Whether we have we been asking the wrong questions?
The newer system with ESG incorporated instead looks at whether the business
model enhances or depletes each form of capital. One must evaluate whether
financial capital has increased in harmony with or at the expense of natural
capital and human capital.
Penalty
-
Issue
Forced to shut down its 1,600MW Farakka thermal power
plant due to water shortage
This also led to higher power prices on India energy exchange
MoEFCC laid down strict standards for controlling emissions of
particulate matter (PM), sulphur dioxide, nitrogen oxide and
mercury, and for reducing water usage by coal-fuelled thermal
power plants. These standards are to be met by December
2017, though the deadline may be extended to 2019
Media articles suggest that some power plants may have to
incur heavy expenditure to meet regulatory requirements on
emissions, and ~20% of power plants in India will have to be
replaced to achieve this norm
Australian delegation asks Adani to drop the USD21.7b
Carmichael coal mine project near the Great Barrier Reef due
to environment concerns
Found to have bribed the Chinese doctors to prescribe
Novartis drugs
The Company agreed to pay the penalty without any
disagreement of the allegation that the China-based
subsidiaries gave gifts and other payments worth hundreds of
thousands of dollars to Chinese health care professionals to
increase sales of Novartis
Found guilty of mis-selling and offering kickbacks to US
doctors. The sanction is the largest healthcare fraud penalty
ever meted out by the US Department of Justice (DOJ)
Exhibit 2: Few cases of ESG related issues leading to fine and settlements
Industry
Power
Company
NTPC
Period and Status
Mar-16
(Ongoing)
Power
Power
companies
with thermal
power plants
Feb-17
(Ongoing)
-
Infrastructure -
Logistics and
energy
Adani Mining
(part of Adani
Group)
Mar-17
(Ongoing)
-
Pharmaceuticals
Novartis India
Mar-16
USD2 m
Pharmaceuticals
Pfizer Global
ACC, ACL,
Binani,
Century,
India Cement,
J K Cement,
Lafarge,
Ramco,
Ultratech,
Jaiprakash
Associates
BP
Adani Port and
SEZ Ltd
Sep-09
£867m
Cement
Energy
Infrastructure -
Ports
2012
Apr-13
INR11.4b (ACC)
INR11.6b (ACL)
INR1.7b (Binani)
INR2.7b (Century)
INR1.8b
(India Cements)
INR1.3b (J K Cements)
INR4.9b (Lafarge)
INR2.6b (Ramco)
INR11.75b (UltraTech)
INR13.2b (Jaiprakash
Associates Limited)
USD 4500m
INR2b
CCI imposed penalties on cement companies for cartelization
Currently, the penalty amount has been contested by the
companies and the matter is subjudice.
11 people killed; Oil spill in the Gulf of Mexico; misstatement
of the amount of oil being discharged into the Gulf
Environment and Forests imposed fine for environmental
damage caused by construction of port project in Mundra,
Gujarat
Source: Media articles, MOSL
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Thematic | Expanding Horizons
Concerns about impending environmental risk
A World Bank report
highlights that rising global
temperatures will result in
increased poverty, health
risks and inflation
2016 was the hottest year since record-keeping began, and in November 2016,
the United Nations (UN) announced that global temperatures have risen 1.2
degrees Celsius above pre-industrial levels, as per a World Bank report. The
report further states that climate change could result in:
More than 100 million additional people living in poverty by 2030.
Crop yield losses reaching as high as 5% in 2030 and 30% in 2080, resulting
in food price increases and inflationary pressures.
Warming of 2-3 degree C could increase the number of people at risk for
malaria up to 5% and diarrhea up to 10% by 2030.
Due to these and multiple other causes of climate change, several new
regulations may crop up. This may expose the companies to additional risks.
Therefore, investors must factor in sustainability measures undertaken by
companies before making investment decisions.
To understand and authenticate the impact on stock prices due to environment-
related risks, let us consider the following case study:
CASE STUDY: The debate on environment – case of BP oil spill
British Petroleum’s (BP) Deepwater Horizon oil spill in the Gulf of Mexico in
2010 was one of the most prominent examples of how environmental risks can
have a meaningful impact on the stock prices.
The incident killed 11 men and released millions of gallons of crude oil into the
water. Clean-up costs of ~USD61.6b were incurred by BP, as per The
Washington post.
BP lost 55% shareholder value between April 2010 and June 2010. The entire
peer group value was eroded, and the company’s stock has continued to
underperform the peers.
Exhibit 3: BP lost 55% shareholder value post the 2010 deepwater horizon oil spill
Source: Company, MOSL
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Thematic | Expanding Horizons
Exhibit 4: BP oil spill led to derating of the entire pack; BP has continued to underperform peers since then
200
160
120
80
40
British Petro
Chevron
Royal Dutch Shell
Exxon Mobil
Source: Company, MOSL
ENVIRONMENT RISK CAN BE VARIED ACROSS COMPANIES
The environment risks for corporates vary primarily depending on the industry they operate in. However, the
processes that each company follows may alter the level of risk that they are exposed to.
Some of the key metrics which are material and monitorable from the environment risk perspective have been
summarized below.
Key measures under Environment risk in the ESG framework
Source: MOSL
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Thematic | Expanding Horizons
CO2 emissions:
Evaluates the extent to which companies face the risks
associated with regulations on levels of CO2, SOX, NOX emissions and the
intensity.
For example, some cement companies use high proportion of pet coke
as fuel at their power plants as it is cost effective compared to coal.
However, it is highly polluting. It is important to note that China has
banned the use of petcoke.
Toxic emissions (SOX, NOX, PM) and waste:
Evaluates the extent to which
companies face the risk associated with contamination, toxic waste disposal
and emission of toxic air pollutants (such as SOX, NOX and particulate
matter) that are harmful for the existence of living beings, targets and
strategies thereof.
For example, the CEA has recently changed regulations for SOX/NOX
emissions for power companies, wherein it has preliminarily identified
72GW of thermal generation capacity that cannot meet revised SOX
norms and would therefore be closed.
Opportunities in renewable sources of energy:
Evaluates the extent to
which companies take advantage of opportunities related to development
of renewable source of power production and utilization of renewables as a
% of total requirement.
Opportunities in clean technology:
Evaluates the extent to which
companies take advantage of opportunities in environment-friendly
technologies.
For example, Thermax manufactures air pollution control, waste and
water treatment solutions, among others. Such companies naturally
perform better on ESG than peers that do not produce any clean
energy-focused products.
Energy conservation/efficiency:
Evaluates the extent to which companies
take initiatives to improve energy efficiency, explore opportunities to
recycle waste heat/energy generated during the production process, etc.
Financing environmental impact:
Evaluation of the extent to which banks
and non-banking financial institutions face the indirect risk of financing
environmentally intensive businesses and their approach toward financing
green businesses.
For example, Axis Bank is one of the few banks which make separate
disclosures on green projects financed by them. The list of such projects
financed includes wind, solar power, biomass, and waste processing,
which account for INR36.68b (1.1%) of total outstanding loans.
Bio diversity and land use:
Evaluating the extent to which companies face
loss of access or reclamation costs or litigations by nature of conducting
operations that damage the natural ecosystem.
For example, tobacco farming requires intensive use of soil and results
in water pollution problems in the surrounding areas due to pesticide
usage.
Water conservation:
Evaluates the risk of operational disruptions and
compliance costs associated with water shortage.
Product emissions:
Evaluates emissions released by the company’s
products into the environment and initiatives taken to reduce these
emissions.
June 2017
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Thematic | Expanding Horizons
Social risk can cause serious disruptions in operations
Healthy relationship with
internal and external
stakeholders is necessary to
contain social risk for
corporates
Social risk under the ESG framework particularly refers to the risks that
companies are exposed to when dealing with (a) internal stakeholders – such as
labor force operating ecosystem and diversity at management level and (b)
external stakeholders – consumers, society etc.
We believe that good relationship with internal stakeholders is essential for
smooth operations. Companies also need to maintain healthy relationships with
external stakeholders to manage reputational risk and discharge their corporate
social responsibility.
To understand the impact on stock prices due to social risks, let us consider the
following case study:
CASE STUDY: Product quality & safety concerns erodes Ranbaxy’s
shareholder value
In September 2008, the US Food and Drug Administration (FDA) issued warning
letters and import alerts, covering 30 generic drugs manufactured at Ranbaxy’s
Dewas and Paonta Sahib plants in India. The issues raised were related to
Current Good Manufacturing Practice (cGMP) / quality systems followed at the
said plants. The issues identified were so severe that it led to the issuance of an
import alert, which bars any imports from the facility into the US.
Further, in January 2009, an unprecedented Application Integrity Policy (AIP)
was invoked on the Paonta Sahib facility of Ranbaxy. The AIP focuses on the
integrity of data and information in applications submitted for agency review
and drug approval. Since the identified issues were related to data integrity
(implying product quality was suspect), these products could have raised risk of
health hazards.
The impact of these events led to erosion in the shareholder value by ~60% in
2008 (refer exhibit 5).
Exhibit 5: Product quality and safety related concerns resulted in ~60% erosion of shareholder value
700
600
500
400
300
200
100
0
Source: MOSL
June 2017
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Thematic | Expanding Horizons
SOCIAL RISK HAS DIVERSE FACETS
Social risk can be quite diversified for companies – some key ones have been summarized below:
Key measures under ‘Social’ risk in the ESG framework
Providing
access to finance
Providing access to
communication
Industrial
relations
Attrition
Providing
access to healthcare
Customer satisfaction
Product
safety
‘SOCIAL’ RISK
IN THE ESG
FRAMEWORK
Diversity at
workplace
Privacy and
data security
Corruption/
Marketing
malpractices
Health &
Safety
Training and skill
development
Source: MOSL
Industrial relations:
Evaluates the relationship between management and
labour/labor unions. It evaluates the risk of potential conflicts that may lead
to operational disruptions.
Attrition:
Evaluates risks associated with white collar workers’ high churn
rate and resultant replacement costs and work disruption.
Diversity at workplace:
Evaluates the diversity of representation from
various groups - age, gender, geography etc in the company.
Training and skill development:
Evaluates the ability to attract, retain and
motivate employees, and conduct training/skill development programs to
June 2017
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Thematic | Expanding Horizons
improve employee performance and morale. Key measures for this include
training programs per employee, workplace complaints and controversies.
Health & safety:
It evaluates the extent to which companies invest to
ensure proper health & safety conditions for employees. Inadequate
measures may lead to employee accidents and, in turn, cause production
disruptions, litigations and injuries/fatalities.
Corruption and marketing malpractices:
Evaluates the exposure to risks
associated with undertaking malpractices to derive disproportionate
benefits in the form of amplified revenues or market share. For example,
some pharma companies bribe doctors to recommend their brand of
pharma products to boost sales, while infrastructure companies bribe
individuals to secure work contracts.
Privacy and data security:
Evaluates the exposure to risks associated with
handling large amount of sensitive personal/financial information of
customers, and security practices adopted to mitigate the risks.
For example, IT companies usually render outsourcing services and thus
have an access to personal data of clients. The key risk for such
companies lies in terms of how they ensure privacy/security of client
data.
Product safety:
It evaluates whether (1) product produced/service rendered
is safe to consume/use and (2) the quality of the product is desirable to the
user and the environment.
Let us take the example of the ongoing Nutella controversy, where the
European Food Safety Authority (EFSA) has raised potential health
concerns due to sufficient evidence of contaminants (which are
carcinogenic) in palm oil used to make Nutella.
This has caused a stir in the European markets, concerning consumption
of Nutella (palm oil is used for create smooth texture and increase shelf
life). As per media articles, Nutella’s profits have taken a 3% hit since
then.
Customer satisfaction:
Evaluates whether the products and services
supplied by a company meet or surpass customers’ expectations.
Providing access to healthcare:
Evaluates the opportunities for long-term
growth through expansion of healthcare access in the underserved areas.
For example, pharmaceutical companies in developing countries are well
positioned to take advantage from providing access to healthcare in rural
areas.
Providing access to finance:
Evaluates the ability to capitalize on
opportunities in under-banked regions through innovation, technology and
distribution channels.
For example, microfinance companies such as Bharat Financial (BFIL)
provide unsecured loans to women under a joint liability model. These
women are part of the population which has never used banking
services.
Providing access to communication:
Evaluates the ability to take advantage
of opportunities arising from underserved markets.
June 2017
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Thematic | Expanding Horizons
Governance – paramount from investment perspective
Corporate governance
essentially involves
balancing the interests of
various stakeholders, such
as shareholders,
management, customers,
suppliers, financiers,
government and the
community
Corporate governance is the system of rules, practices and processes by which a
company is directed and controlled. Corporate governance essentially involves
balancing the interests of various stakeholders, such as shareholders,
management, customers, suppliers, financiers, government and the community.
Since corporate governance also provides the framework for attaining company
objectives, it encompasses practically every sphere of management, from action
plans and internal controls to performance measurement and
corporate disclosure.
The importance of corporate governance can be best understood from the case
study of Satyam Computers.
CASE STUDY: Corporate governance failure at Satyam Computers
Investors must be conscious
of transparency and
accountability of companies
that they invest in
In January 2009, the founder of Satyam Computer Systems, a renowned Indian
IT company that attracted huge amounts of foreign investment, confessed to
committing fraud. He also admitted that he had been cooking the books for
seven long years in order to keep control of the company.
Investors and regulators, alike, were surprised by the incident. This led to
erosion of shareholder value by a whopping ~87% at the time of the incident.
Exhibit 6: Corporate governance issues led to ~87% decline in Satyam’s shareholder value
600
500
400
300
200
100
0
CG concerns
cause 87% fall
Source: Company, MOSL
Governance has multiple parameters to measure
As discussed earlier, corporate governance comprises system of rules, practices and processes by which a
company is directed and controlled. Thus, the measurement of governance parameters can be comprehensive.
These parameters are certainly common across sectors. Some key parameters have been summarized in the
exhibit below.
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Thematic | Expanding Horizons
Key measures under ‘Governance’ in the ESG framework
Alignment of
interests
Accounting
practices
Related party
transactions
Board member
attendance
Product profile
concentration
Geographical
concentration
Executive
compensation
Board
independence
Rotation of
independent
directors
Rotation of
auditors
Execution and
financial risk
Capital allocation
Investment in
technology/R&D
Customer
concentration
Vendor
concentration
Regulatory risk
Piracy
Source: MOSL
Related party transactions (RPT):
Evaluates the transactions between the
company and its “related entities,” such as associates, JVs and substantial
shareholders. RPTs may lead to shifting of profit out of the company to
other entities, which could be detrimental to minority shareholders.
However, we note that RPTs are not always abusive in nature; at times, they
can be undertaken to create operational synergies and save costs.
Alignment of interest:
Evaluates whether management or promoter group
have competing businesses in unlisted/listed entities promoted by them,
thereby questioning vested interests of the promoters.
Accounting practices:
Evaluates accounting and reporting practices in order
to raise concerns around overall effectiveness.
Executive compensation:
Evaluates the rationality in executive
compensation. The highest paid executives are now being questioned on
the level of remuneration, bonus paid, etc., by various investors.
Board Independence:
Evaluates independence of the board in decision
making without personal bias. In India, there are regulatory requirements
(as per Clause 49), where if the Chairman of the Board is a non-executive
director, at least one-third of the Board should comprise independent
directors, and in case s/he is an executive director, at least half of the Board
should comprise independent directors.
Rotation of independent directors:
Evaluates whether the independent
directors are regularly rotated in order to preserve board independence. As
per the Companies Act 2013, independent directors need to be mandatorily
June 2017
17

Thematic | Expanding Horizons
rotated after a term of 10 years of being on the board. This is also a good
practice followed globally.
Rotation of auditors:
Evaluates whether the auditors are regularly rotated
in order to preserve auditor independence.
Board member attendance:
Evaluates whether the board members are
regularly attending board meetings and AGMs in order to resolve critical
issues in the regular course of operations.
Business concentration risks:
Evaluates risks associated with concentration
of product profile, geography, customers, and vendors.
For example, Eicher Motors’ manufacturing facilities are concentrated
only at one location for each of its two business segments. This could
lead to significant geographical risks, as seen in the past.
Regulatory risk:
Evaluates risks associated with regulatory changes that may
have an adverse impact on the operations of a company.
Investment in technology/R&D:
Evaluates the extent to which companies
are investing in R&D, when compared to peers, in order to stay ahead of the
curve.
Execution and financial risk:
Evaluates the execution (project completion,
managing multiple projects simultaneously, etc.) and financial risks
(financial closure, potential delays in repayment, etc.) associated with
projects under implementation.
June 2017
18

Thematic | Expanding Horizons
Approaches to sustainable investing
Globally, there are multiple ways to invest based on sustainability parameters
which are summarized below:
Multiple approaches to sustainable investing
EXCLUSIONARY
SCREENING
Involves avoiding certain exposures based on specific criteria
THEMATIC
INVESTING
Involves adopting strategies based on trends such as clean
energy, water and agriculture
IMPACT
INVESTING
Investment in companies that intentionally create a
measurable social and environmental impact
ESG INVESTING
Proactively considers ESG criteria, along with financial
aspects, to identify risks/opportunities during the
investment process.
Source: MS Institute for Sustainable Investing & Bloomberg L P, MOSL
June 2017
19

Thematic | Expanding Horizons
ESG – Making investors wealthy globally
Sustainable investments grew in both absolute and relative terms in the four years
post 2012. SRI assets grew 72% to USD23t in 2016 from USD13.3t in 2012 (CAGR 15%),
outpacing growth of 40% in total professionally managed assets (CAGR 9%).
Europe alone accounts for 53% of global SRI assets as of 2016. However,
Australia/New Zealand recorded the highest growth rate of more than 100% over
2012-16 (30% CAGR).
The S&P 500 ESG index has outperformed the benchmark S&P 500 index by 500 bps
over the past seven years. In the emerging markets, the MSCI EM ESG index has
significantly outperformed the MSCI EM index by over 4500 bps.
ESG investing has created shareholder wealth for investors globally
S&P 500 ESG index & MSCI
EM ESG index have
outperformed the S&P 500
& MSCI EM indexes over
the past 7 years
We observed the region-specific benchmark indices to understand how ESG-
conscious companies perform relative to other companies. The S&P 500 ESG
index has outperformed the benchmark S&P 500 index by 500 bps over the past
seven years. In the emerging markets, the MSCI EM ESG index has significantly
outperformed the MSCI EM index by over 4500 bps.
In India, however, when we compare MSCI ESG India index with Sensex or Nifty,
the trend is not replicated. This can be ascribed to the lack of awareness about
ESG-related risks and disclosures thereon.
However, the increasing focus of institutional investors on this subject is
creating awareness among corporates, resulting in an increasing number of
corporates publishing their sustainability reports, despite it is not mandatory to
do so. We believe this trend will lead to better transparency and judgment on
ESG criteria for these companies.
Exhibit 8: Outperformance of EM ESG v/s EM index
150
120
MSCI EM ESG index
MSCI EM
Exhibit 7: Outperformance of ESG index v/s S&P 500 index
S&P 500 ESG Index
250
S&P 500 Index
150
90
60
50
30
Source: Bloomberg, MOSL
Source: Bloomberg, MOSL
June 2017
20

Thematic | Expanding Horizons
Exhibit 9: Underperformance of India ESG index v/s Nifty
170
130
90
50
MSCI India ESG Index
NIFTY Index
Exhibit 10: Underperformance of India ESG index v/s Sensex
MSCI India ESG Index
170
130
90
50
SENSEX Index
Source: Bloomberg, MOSL
Source: Bloomberg, MOSL
SRI assets expanded exponentially in four years
SRI assets account for
USD23t (26%) of total AUM
globally
Sustainable investing grew in both absolute and relative terms in the four years
post 2012. SRI assets grew 72% to USD23t in 2016 from USD13.3t in 2012,
(CAGR 15%), outpacing growth of 40% in total professionally managed assets
(CAGR 9%) (refer exhibit 11, 12, 13 and 14).
As of 2016, SRI assets accounted for 26% of total assets under management
globally, with the highest increase seen in Australia and New Zealand (refer
exhibit 15).
This represents an increase in the number of socially conscious investors and
thrust on sustainability across regions. The regions covered include Europe,
Canada, the US, Australia/New Zealand and Asia.
Exhibit 12: 26% of global AUM in 2016 was under SRI assets
USD 23
Trillion
SRI assets
Exhibit 11: 22% of global AUM in 2012 was under SRI assets
USD 13.3
trillion of
SRI assets
USD 62 Trillion
Total Assets
under
professional
management
22%
26%
USD 87 Trillion
Total Assets
under
professiomal
management
Source: 2016 Global Sustainable Investment Review, MOSL
Source: 2016 Global Sustainable Investment Review, MOSL
Exhibit 13: Global AUM grew at 9% CAGR during 2012-16
(USD Trillion)
62
87
Exhibit 14: SRI assets grew at 15% CAGR during 2012-16
USD Trillion
23
13
2012
2016
2012
2016
Source: 2016 Global Sustainable Investment Review, MOSL
Source: 2016 Global Sustainable Investment Review, MOSL
June 2017
21

Thematic | Expanding Horizons
Exhibit 15: Australia/New Zealand had the steepest growth in SRI managed assets
Proportion of SRI relative to total managed assets
53%
49%
38%
20%
11%
22%
18%
3%
Europe
Canada
United States
Australia/New
Zealand
1%
0%
Japan
3%
2012
2016
51%
Asia ex Japan
Source: 2016 Global Sustainable Investment Review
Australia and New Zealand accounted for largest increase in SRI assets
Australia/New Zealand
recorded the highest CAGR
of 30%
Europe alone accounted for 53% of global SRI assets as of 2016. However,
Australia/New Zealand recorded the highest growth rate at over 100% (30%
CAGR) over 2012-16.
While the European market has matured with respect to growth in SRI assets,
the US and Canada continue to grow at over 15% CAGR.
Over 2012-16, Japan has been one of the fastest growing regions, as per the
new surveys by the Japan Sustainable Investment Forum (JSIF) that provided
information for the first time on numerous large asset owners.
While sustainable investing is not largely practiced in Asia, investor interest in
such investment products is likely to continue increasing.
Exhibit 16: At 53%, Europe has the largest share of global SRI assets
USA, 38.1%
USD 23
Trillion
SRI assets
Australia/
NZ, 2.3%
Canada, 4.7%
Asia ex japan,
0.2%
Japan, 2.1%
Europe, 52.6%
Source: 2016 Global Sustainable Investment Review
Most of the SRI assets referred to are in Europe (53%) and the US (38.1%), but
the proportion of such assets has increased faster (24% CAGR) in the US than in
Europe (8% CAGR) over 2012-16.
June 2017
22

Thematic | Expanding Horizons
Exhibit 17: Europe has the largest SRI assets globally
Growth of
SRI
Assets by
Region
(NAV in billions of $)
12040
8758
3740
589
Europe
USA
1086
178
516
64
Asia*
52
10
474
Japan
8723
2012
2016
Canada
Australia/NZ
Notes:
Source: 2012 and 2016 Global Sustainable Investment Review, MOSL
All 2016 assets are converted to USD based on exchange rates at year-end 2015.
Australia/NZ assets under management data is up to June 30, 2011 (for 2012 data).
The total assets under professional management for the regions—whether engaged in sustainable investment or not—were reported by the
members of GSIA at USD62t in 2012. In comparison, TheCityUK estimates global managed assets at USD79.8t, which excludes alternative funds
and private wealth funds, but covers more of the globe. See:
http://www.thecityuk.com/assets/Uploads/Fund-Management-2012.pdf
Rising trend of funds that integrate ESG into investment consideration
UN PRI has 1500 signatories
from over 50 countries
The United Nations-supported Principles for Responsible Investment (PRI) is a
global body working to understand the investment implications of ESG factors
and to support its international network of investor signatories in incorporating
these factors into their investment and ownership decisions.
The organization prescribes investment principles that offer possible actions for
incorporating ESG issues into investment practice. The Principles are ‘voluntary
and aspirational’ and they do not have minimum entry requirements or absolute
performance standards for responsible investment.
However, signatories have an obligation to report on the extent to which they
implement the Principles through the annual Reporting and Assessment
process. There are nearly 1,500 signatories, from over 50 countries,
representing USD62t in AUM (refer exhibit 18).
The signatories to the UN-PRI comprise asset owners, investment managers and
service providers (refer exhibit 19). Some of the largest funds in the world are
listed as the most active signatories to the UN-PRI (refer exhibit 20).
Exhibit 18: UN-PRI has nearly 1,500 signatories from over 50 countries
Assets under management (US$ trillion)
Number of Signatories
1070
719
263
6.5
10
362
13
531
18
21
24
800
32
34
1188
1380
59
45
1500
62
1260
100
Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16
Source: UN PRI
June 2017
23

Thematic | Expanding Horizons
Exhibit 19: Of the 1,500 signatories, 92% are IMs and asset owners
Service providers,
8%
Asset owners, 36%
Investment
Managers, 56%
Source: UN PRI
Exhibit 20: 2015-16 UN-PRI list of most active signatories
PRI signatory
ACTIAM
Aviva Investors
Bâtirente
BMO Global Asset Management
Boston Common Asset Management
Boston Trust & Investment Management Company
California Public Employees’ Retirement System
CalPERS
Calvert Investments
CCLA
Domini Social Investments
Hermes Fund Managers Limited
Interfaith Center on Corporate Responsibility
Miller Howard Investments
MN
NEI Investments
Pax World
PGGM Investments
Rathbone Brothers Plc
Robeco
Trillium Asset Management
Source: UN PRI AR 2016
June 2017
24

Thematic | Expanding Horizons
India is ESG-positive, but at a nascent stage
67% of BSE Sensex
companies and 62% of NSE
Nifty companies disclose
sustainability reports
voluntarily
While India is at a nascent stage of integrating sustainability investing, we note that
business responsibility reporting (BRR) is mandatory for the top 500 companies by
market cap listed on the NSE and the BSE. Sustainability reporting, however, is not
mandatory.
BRR requires the companies to answer to a list of standardized questions, sometimes
in a yes/no format. This kind of disclosure on ESG is insufficient, in our view.
Thus, sustainability reporting is necessary as it helps obtain detailed information on
material ESG issues relevant to industry/company with suitable explanations.
Although disclosures are at a nascent stage in India, 67% of BSE Sensex companies and
62% of NSE Nifty companies disclose sustainability reports voluntarily. This indicates
that the companies want to perform well on sustainability.
BRRs is mandatory for most listed corporates …
BRR is mandatory for the top 500 companies by market cap listed on the Indian
exchanges. Releasing sustainability report, however, is not mandatory.
From what we have seen, BRR requires the companies to answer to a list of
standardized questions, sometimes in a yes/no format. This kind of disclosure
on ESG is insufficient, in our view.
We believe separate sustainability reports will be very helpful, as they disclose
detailed information on (i) material ESG issues relevant to industry/company
with suitable explanations, (ii) targets to be achieved and (ii) roadmap to
achieve targets, among others. Sustainability reports provide a more holistic
view of the company’ ESG activities.
We believe that the trend of reporting SRs will continue gaining steam due to
rising investor thrust – companies are likely to become more conscious about
ESG-related issues over the coming few years.
We believe that corporates are actively embracing ‘sustainability’. Although
sustainability disclosures are at a nascent stage in India, we note that 67% of
BSE Sensex 30 companies and 62% of NSE Nifty 50 companies are disclosing
sustainability reports. Globally, the number is higher in both number and
percentage: S&P 500 companies reporting data on ESG increased to 81% in
2015, from 20% in 2011 (refer exhibit 22).
These 31 NSE Nifty 50 companies disclosing SRs account for a market cap of
USD641b (as on June 9, 2017), representing almost 59% (Nifty MCap) of total
market cap of companies listed on the NSE.
Moreover, these companies have been publishing sustainability reports, even
though it is not mandatory to do so. This indicates that the companies want to
perform well on sustainability.
Some companies such as Mahindra & Mahindra have started conducting ESG
concalls. The company highlighted during the call in March 2017 that it was
toying with the idea of utilizing a new ESG-acquiescent metric (viz. emission
reduced/PBP) to determine project preferences.
…however, sustainability reports (SRs) are vital for evaluation
India is embracing ‘sustainability’ actively
Companies such as
Mahindra and Mahindra are
toying with the idea of
utilizing newer metrics
(emission reduced/PBP) in
order to determine
preference
June 2017
25

Thematic | Expanding Horizons
Exhibit 21: 62% of Nifty 50 companies disclose sustainability reports
BRR and SR disclosure
BRR only
BRR+SR
67%
62%
38%
NSE Nifty 50
33%
S&P BSE sensex
Source: Sustainability Outlook’s report by India Responsible Investment Working Group 2014, MOSL
Exhibit 22: 81% of S&P 500 companies disclose information on ESG
S&P 500 companies - disclosure on ESG
Reporters
28%
Non-reporters
25%
19%
47%
80%
53%
20%
2011
2012
72%
75%
81%
2013
2014
2015
Source: Governance and Accountability Institute
Exhibit 23: 62% of the Nifty 50 companies disclose sustainability reports and BRR
Sr. No. NSE Nifty 50
1 ACC Ltd.
2 Adani Ports and Special Economic Zone Ltd.
3 Ambuja Cements Ltd.
4 Asian Paints Ltd.
5 Axis Bank Ltd.
6 Bharat Petroleum Corporation Ltd.
7 Bharti Airtel Ltd.
8 Bharti Infratel Ltd.
9 Coal India Ltd.
10 Dr. Reddy's Laboratories Ltd.
11 GAIL (India) Ltd.
12 HCL Technologies Ltd.
13 HDFC Bank Ltd.
14 Hindalco Industries Ltd.
15 Hindustan Unilever Ltd.
16 I T C Ltd.
Sr. No.
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
NSE Nifty 50
IndusInd Bank Ltd.
Infosys Ltd.
Larsen & Toubro Ltd.
Maruti Suzuki India Ltd.
NTPC Ltd.
Oil & Natural Gas Corporation Ltd.
Reliance Industries Ltd.
Tata Consultancy Services Ltd.
Tata Motors Ltd.
Tata Power Co. Ltd.
Tata Steel Ltd.
Tech Mahindra Ltd.
UltraTech Cement Ltd.
Wipro Ltd.
Yes Bank Ltd.
Source: MOSL, Company
Exhibit 24: 67% of S&P BSE Sensex companies disclose both SR and BRR
Sr. No.
1
2
3
4
5
6
7
8
9
10
S&P BSE Sensex
Adani Ports and Special Economic Zone Ltd.
Asian Paints Ltd.
Axis Bank Ltd.
Bharti Airtel Ltd.
Coal India Ltd.
Dr. Reddy's Laboratories Ltd.
GAIL (India) Ltd.
HDFC Bank Ltd.
Hindustan Unilever Ltd.
I T C Ltd.
Sr. No.
11
12
13
14
15
16
17
18
19
20
S&P BSE Sensex
Infosys Ltd.
Larsen & Toubro Ltd.
Maruti Suzuki India Ltd.
NTPC Ltd.
Oil & Natural Gas Corporation Ltd.
Reliance Industries Ltd.
Tata Consultancy Services Ltd.
Tata Motors Ltd.
Tata Steel Ltd.
Wipro Ltd.
Source: Company, MOSL
June 2017
26

Thematic | Expanding Horizons
Some challenges on integrating ESG measures still remain
The emphasis of integrating sustainability in investment decision has increased
demand for greater disclosure and reporting of E&S-related information by
corporates in India. However, we note that E&S information is both limited and
dispersed. Further, what is perceived as acceptable set of ESG criteria is
subjective.
There are also other key challenges that obstruct full integration of ESG:
Awareness of ESG investing and its integration
Lack of standardization of data across companies in a sector, therefore,
comparability is a challenge
Availability and consistency of data
Quantification difficulty
Lack of globally accepted framework for reporting
Valuations may not reflect ESG risks until the event has actually occurred
Lack of existing benchmarks to establish an adverse or better performance
on ESG principles. Therefore, performance is measured in comparison with
peers and its own past performance.
The ‘Sustainability’ ecosystem is currently driven by investor ambition to
support sustainable investments and comply with global organizations such as
the UN-PRI to which they are signatories.
The significance of integrating sustainability analysis is reinstated when we look
at the recent case of BHEL. In May 2017, Norway’s $940 billion sovereign wealth
fund excluded Bharat Heavy Electricals Ltd on environmental grounds.
The company is building a coal-fired power plant close to areas with
“universally unique environmental qualities in the Sundarbans, the world’s
largest mangrove forest, in southern Bangladesh’. The fund believes that
“there’s an unacceptable risk of the company contributing to or being
responsible for severe environmental damage”
The world’s largest wealth fund takes into account ethical rules
encompassing human rights, some weapons production, corruption, the
environment, coal and tobacco when deciding on its investments.
Sustainability analysis is critical for investment analysis to evaluate returns on
unpriced capital other than financial capital such as natural capital, human
capital, and intellectual capital in order to attune the valuations accordingly.
While globally, sustainability has evolved at a much faster rate, in India - the
uptick on sustainability has been rather slow, as sometimes the benefits of
sustainability reporting/analysis are not clearly understood.
We note that the materiality varies across sectors and is primarily dependent on
the nature of the business and the country in which it operates. Also, within
each sector, company-level performance is dependent on efforts taken by the
company to mitigate risks.
We believe that manufacturing sectors are more prone to the environment and
social risks. On the other hand, the services sector, which largely involves
human capital, is more exposed to the social risk. Governance risk
predominantly applies almost evenly across sectors.
27
Sustainability – the way forward for India
Materiality of ESG measures varies across sectors
June 2017

Thematic | Expanding Horizons
We have created a thought process and set it in a framework to evaluate
sustainability from the Indian context.
Oil & Metals
Gas
Power
Indian context - Materiality of ESG measures varies across sectors
Cement Capital
goods
Auto
Banks Telecom Pharma
IT
FMCG
Environment
CO2 emissions
Toxic emissions
Waste disposal
Opportunities in renewable
sources of energy
Opportunities in clean technology
Energy conservation/efficiency
Financing environmental impact
Biodiversity and land use
Water conservation
Product emissions
Source: MOSL
Social
Industrial Relations
Attrition
Diversity at workplace
Training and skill development
Health & Safety
Corruption/Marketing malpractices
Privacy and data security
Product safety
Customer satisfaction
Providing access to healthcare
Providing access to finance
Providing access to communication
Governance
Related party transactions
Alignment of interests
Accounting practices
Executive Compensation
Board Independence
Rotation of independent directors
Rotation of auditors
Board members attendance
Product profile concentration
Geographical concentration
Customer concentration
Vendor concentration
Regulatory risk
Investment in technology/ R&D
Execution and financial risk
Note: The above matrix is indicative and not exhaustive
June 2017
28

THEMATIC/STRATEGY RESEARCH GALLERY

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