Organisation: SBI Funds Management
HQ country: India
Signatory type: Investment manager
COVERED IN THIS CASE STUDY
Asset class: Listed equity
SBI Funds Management (SBIFM) is currently the largest asset manager by AUM in India, offering a wide range of actively managed mutual funds and index funds. We have introduced a new process of assessing IPOs using a proprietary ESG framework. The process makes use of the Red Herring Prospectus (RHP) filed by companies with the regulator, publicly available information through news, articles, blogs, and databases, as well as corporate engagement to understand ESG initiatives. SBIFM’s process for IPO ESG assessment has enabled the investment team to apply an ESG lens to investment decisions and engage with companies prior to investing.
SBIFM recognised that when companies are looking for funding is the best time to inform them of our expectations, and to ensure they understand that strict regulatory scrutiny will be standard as a listed entity. SBIFM found in-depth engagement during the pre-investment stage to be an effective tool to discharge its fiduciary responsibility. Rationales for this approach include:
- There is no, or limited, availability of ESG data from private companies, and consequently no ESG ratings/scoring available from third-party vendors, causing difficulty in applying an ESG lens to investment decisions.
- It is easier to leverage corporate engagement in the pre-IPO period and easier to monitor and track companies due to clear expectations set before investment.
- There is a benefit to the investment ecosystem from companies’ improved ESG orientation.
The process helped SBIFM create an ESG investment environment in which fundamental financial analysts were able to appreciate ESG issues from the beginning and to make discussions part of their investment thesis.
Over the year, the combined teams of fundamental analysts, ESG analysts, and fund managers were able to engage with companies on discussions around ESG. This blurred the lines between the roles of fundamental financial analysts and ESG analysts, and created a deeper understanding of the financial materiality of ESG factors. This is new in emerging markets such as India, where integration of ESG concepts in investments is often still nascent.
The approach in practice
The proprietary framework includes a questionnaire of 50 questions under ESG pillars. The questionnaire addresses exposure (business risks), management of ESG risks, and controversies relating to these factors. Since the companies are low on ESG disclosures, SBIFM has prepared sector-based numerical ESG exposure scores with the help of the Sustainability Accounting Standards Board’s (SASB) materiality map.
The controversies are captured through a rigorous process of news searches and analyst insights. The ESG risk management part is accessed from public disclosures in annual reports/websites and RHP documents filed by the company. The remaining questions are addressed by engaging with the company. These three elements are fed into a consolidated ESG score, which is then compared with the internal threshold for investments.
A chemical company with a pesticides business launched its IPO in 2021. The standard process of fundamental financial analysis was complete. The company was the sole manufacturer of its products in India, was expanding its capacity by 50%, and had potential in both domestic and international markets. On those grounds, the company looked promising.
However, the ESG assessment framework highlighted numerous red flags. Some of the issues identified were very low salaries of executives, involvement in criminal cases related to misbranding of chemicals, various independent director and auditor resignations in the same timeframe, with vague reasons and generally poor governance. Later, these issues were also covered by one of the leading business newspapers in the country.
Consequently, SBIFM did not invest in the company (except a small amount in a commodity fund). While many factors may have contributed, we note that the company’s stock price has been on a downward trajectory and has seen a 28% drop in the year since listing. Having the ESG lens on this IPO helped save loss of value for SBIFM. In future, we expect the ESG assessment process to help SBIFM to make informed decisions about companies that may appear to have attractive financials.
Learnings and challenges
ESG is contextual: ESG assessments are contextual, not only with respect to sectors, size, and markets, but also the kind of asset class that is being rated. ESG materiality may differ based on the businesses, its size, and whether the company is listed or unlisted. We learnt that the most efficient way to collect data on unlisted/newly listed firms is to engage prior to investment.
Engagement may not address all the issues: SBIFM realised that active engagement is a long process and may take multiple years and still not yield the expected results. Going forward, SBIFM will endeavour to formalise escalation processes for failed or stalled engagements.
The process currently addresses business risks based on the SASB materiality map. However, companies with innovative business models, such as tech-based ride or food aggregators may not be mapped to a single industry. SBIFM plans to create a model to allow mapping of new sectors against internally-identified material risks.
From 2023, Indian capital markets regulator SEBI will mandate ESG disclosures for 1,000 listed companies in India in the form of Business Responsibility and Sustainability Reports (BRSR). SBIFM is exploring automation techniques to use data from BRSRs to complete the ESG questionnaire, which will reduce manual efforts in searching and filling data.
For new IPOs with no BRSRs, SBIFM will use similar automation to get data from RHPs and annual reports. Simultaneously, SBIFM will lobby with the regulator to mandate ESG disclosures in RHP documents. SBIFM will design specific, issue-based engagements with companies, and will communicate and record clear objectives and expectations. We will formalise escalation methodologies as per the stewardship code.
We have found that ESG assessment at IPO level has saved value for SBIFM, while ongoing engagement has led to improvements in ESG practices. There have been IPOs where a company initially looked promising, but ESG assessment indicated many red flags. In some cases, the engagement process helped the company to improve its disclosures and pursue a better ESG trajectory.