With sustainability taking centre stage in an enterprise’s strategic and operating environment, ESG (short for environmental, social and governance) has become quite the buzzword in corporate circles, both Indian as well as global. The past few years have seen a ballooning of ESG-focussed funds—including both private equity (PE) and venture capital (VC) funds—in India. Per a report from Bain & Co., assets under management (AUM) by ESG-focussed PE funds in India more than doubled to $650 million in 2021. Another report from Bain says the AUM of these PE funds is expected to grow 90 per cent in the next five years, up from 39 per cent in the past five years. For start-ups, data from analytics firm Entrackr shows that of the top 25 early-stage deals from January-June this year, six were environment-related.
Typically, an ESG fund shortlists companies that score high on ESG parameters, and then looks at factors like financial viability of its product and the profit it is likely to give, before making an investment. Of course, every fund has its own investment strategy. “As an ESG-focussed fund, we’re able to bring more value to our companies,” says Shailesh Vickram Singh, Founder of Climate Angels, a VC fund focussed on start-ups working in ‘clean’ areas of energy, mobility, water, food and cities. “A majority of [PE/VC] funds today will have some funds with an ESG and climate focus. Right now, there are a lot of start-ups, but we’ll see a lot more corporates coming in.”
However, there’s a twist. Within ESG, the ‘E’ or environmental part—climate change, waste management, pollution, deforestation, etc.—has been the primary focus for both start-ups and legacy organisations, while investments in the ‘social’ and ‘governance’ parts continue to be sluggish. Singh says ESG is in its infancy in India, even though funding has jumped for the ‘environment’ part. “The number of start-ups focussed on the environment is way more than those focussing on social and governance, and hence, funding activity shows a similar trend,” says Singh.
Sambitosh Mohapatra, ESG Platform Leader at PwC India, agrees that ESG funding in India is still at a nascent stage. Per industry estimates today, around 10.5 per cent bonds in emerging markets are ESG-linked. This share is 25 per cent in China. But in India, it is only 0.7 per cent. So, there is room for growth. According to Mohapatra, the need of the hour is more ESG-specific policy support from the government. At the same time, he says people are increasingly seeing the benefit of embedding ESG into business strategy: “Every company will put it in their strategy this year. By next year, they’ll be reporting their sustainability performance, and then significant pressure will come to increase those projects.”
More bankable ESG projects could come up within the next two to three years, he adds. In fact, globally, many investors have stopped putting their money into companies that are perceived to be polluting, or which do not have a reputation of upholding environmental norms. The same trend could eventually percolate into India.
ESG rising
The good news is that there is visible traction in the segment with many ESG-focussed funds coming up. Aavishkaar Capital, the Mumbai-headquartered impact investing arm of Aavishkaar Group, has announced the launch of a $250-million ESG-first fund in collaboration with German investment and development bank KfW. The fund will focus on investing in Asia and Africa to strengthen ESG practices of mid-cap businesses and offer them growth capital.
Within ESG, some funds focus on tech used to address climate change. Globally, climate tech is one of the hottest investment areas for VCs, with $400 billion being invested across 600-plus deals in 2021, according to Climate Tech VC, a climate tech research and publication outfit. Such Indian climate-tech businesses received about $1 billion in VC funding between 2016 (when the Paris Agreement was signed) and 2021, per a report jointly brought out by data provider Dealroom.co and London & Partners, the promotional firm for the City of London. For example, Mumbai-based VC firm Avaana Capital raised its second climate tech-focussed fund with a target corpus of $150 million in August 2022.
Climate Angels’ Singh points out that electric vehicles form almost 50 per cent of the funding activity within the ESG space. “Other areas seeing traction are carbon capture, energy efficiency, waste management, climate tech, etc. Agri-tech will start coming on the radar in the next one to two years,” he says, adding that the total amount raised in the past 12 months by start-ups focussed on fighting climate change is $50 million, including $2.5 million from Climate Angels.
Large corporates are also taking steps in ESG. For example, JSW Cement recently signed its first sustainability-linked loan of Rs 400 crore ($50 million) with MUFG Bank India, and plans to deploy these funds to achieve its capacity target of 25 MTPA with increasing focus on sustainability. For the past several years, large companies have been mandated by the government to spend 2 per cent of their net profits on CSR (corporate social responsibility) activities. So, logically, this ‘practice’ should help them on the path to ESG. But it’s not as simple as it sounds. “With corporates, the platforms that have been developed are, in a manner of speaking, rigid and the turnaround takes a lot of time. That’s where I see a lot of potential for start-ups,” says Aalok A. Deshmukh, Co-founder and MD of Superhuman Race that works with the government, non-profits, individuals and large corporates to enable them to measure and celebrate their ESG-focussed activities. “The bigger companies are not able to do it as efficiently,” says Deshmukh.
Still, with their experience of CSR, the presence of large companies in ESG should help push the ‘S’ part of ESG. Per a survey conducted by asset management firm BNP Paribas, 70 per cent of investors mentioned that social considerations are expected to become extremely or very important in the future. This shows an increase of 20 percentage points from before the onset of Covid-19, with those expecting governance (or the ‘G’ part of ESG) to grow as high as 76 per cent, a rise of four percentage points.
The challenges
While there is an uptick in ESG investing, significant challenges persist. A big one, per experts, is ‘greenwashing’, which essentially means giving misleading information about how a company’s products are environmentally sound. In an agenda note, the World Economic Forum pointed out that ‘greenwashing’ is a top concern among global institutional investors.
And while there is more funding available, it isn’t enough. “This sector needs a more robust ecosystem. The government can have a fund of funds of Rs 4,000-5,000 crore earmarked only for ESG,” says Singh. Per experts, one of the answers to the funding challenge is blended finance: a combination of private or public capital and philanthropic or development funds in a way that the latter assumes more risk in a development project. And blending can help increase the pool of funds. “Where the money will come from will depend on the project and the kind of investor or bank one is approaching,” says PwC’s Mohapatra.
As funding activity towards the social and governance parts of ESG increases, the Indian PE/VC ecosystem, start-ups and corporates are all set to benefit. Per Bain and Co., India could witness annual PE/VC deal values of around $50 billion-plus more frequently from a base of deals worth $38.5 billion reported in 2021, of which a good chunk would be ESG-focussed. It is a great time, therefore, for investors to exist in the ESG space in India as the sun starts to shine on the sector.
@PLidhoo