Financing Global Transition Through Green Bonds

Green bonds were first issued by the World Bank in 2008 to push for private sector participation in projects contributing to a better environment and mitigating the risks of climate change. The Intergovernmental Panel on Climate Change (IPCC), which includes more than 1,300 scientists from the United States and other countries, forecasts a temperature rise of 2.5 to 10 degrees Fahrenheit over the next century.

Hence, it was essential to have an alternative mode of financing that would attract investors and global institutions’ attention towards projects, specifically catering to environment friendly projects thereby also ensuring that governments globally achieve their commitments in the reduction of emissions of CO2 and greenhouse gases.

The Indian government, in particular, has introduced measures and brought out amendments to regulations to encourage the construction of renewable energy projects. However, the evolution and growth of environment focused projects is mostly dependent on the modes of financing available in the market. In this article, we shall review primarily the laws applicable to green financing.

Types of Green Bonds

Green bonds are regular bonds with the distinction that the money raised from the investors must only be used to finance projects that are environmentally friendly. More precisely, green bonds finance projects that are aimed at renewable energy infrastructure, energy-efficient buildings, clean transportation, and waste management.

There are primarily four types of green bonds, mainly distinguished based on the collateral or security being provided in the issuance of green bonds:[1]

  • Green ‘Use of Proceeds’ Revenue Bond: These types of green bonds are secured by the projects producing income.
  • Green ‘Use of Proceeds’ Bond: These types of bonds are secured by assets.
  • Green Securitized Bond: These types of green bonds are secured by large pools of assets.
  • Green Project Bond: These types of green bonds are secured by the balance sheet and assets of the project.

 

Green Bond Principles

The voluntary best practice guidelines called the Green Bond Principles (GBP) were established in 2014 by a consortium of global investment banks.[2]

The GBP accentuates the required transparency, accuracy and integrity of information that will be disclosed and reported by issuers to stakeholders. The GBP has four core components, which include:

  1. Proceeds must be used for green projects;
  2. Process adoption for project evaluation and selection;
  3. Maintaining transparency in the management of proceeds; and
  4. Reporting of information pertaining to the use of the proceeds.

The GBP is a framework devised with the goal of accentuating the role that global debt capital markets can play with respect to environmental and social sustainability.

In India, the Securities and Exchange Board of India (SEBI) notified a circular dated May 30, 2017, which provides for the Disclosure Requirements for Issuance and Listing of Green Debt Securities in India, and the definition of a green bond has been given under the circular, which is within the outline of the International Capital Market Association’s GBPs with certain deviations.

Evolution of  Green Bonds in India

India’s first green bond was issued in 2015 for renewable energy projects such as solar, wind, hydro, biomass and power by Yes Bank. In the same year, another leading banking institution, Exim Bank of India, issued a five-year, $500 million green bond, which is India’s first dollar-denominated green bond.

Subsequently, Axis Bank[3] launched India’s first internationally listed and certified green bond and raised $500 million to finance climate change projects and solutions around the globe and use the bond proceeds to promote green energy in urban and rural areas, transportation and what is called ‘green-blue infrastructure’ projects in India and abroad. KPMG provided third-party independent assurance as per the requirements of the GBP (established by the International Capital Market Association). [4]

Regulatory Framework Governing Green Bonds in India

In 2017, the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (NCS) defined a “green debt security” (GDS) as debt securities used for funding project(s) or asset(s) falling under any of the following broad categories:

Renewable Energy, Clean Transportation, Sustainable Water Management Systems, Climate Change Adaptation, Energy Efficient and Green Buildings, Sustainable Waste Management, Sustainable Land Use, including Sustainable Forestry and Agriculture, Afforestation, Biodiversity Conservation; and any other categories specified by SEBI.

Issuance of listed green debt securities in India must be in compliance with all the following regulations:

  1. Chapter IX of the SEBI operational circular covers the issue and listing of Non-Convertible Securities (SEBI Operational Circular).
  2. The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations).
  3. The SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021.

However, there are no specific guidelines mentioned for unlisted green debt securities other than the general requirements for the issuance of unlisted green debt securities.

In the month of February 2022, Finance Minister Nirmala Sitharaman announced in her budget speech that India will issue sovereign green bonds to fund green projects. In FY23, the government will issue sovereign green bonds as part of its borrowing programme. The funds will be used to fund public-sector projects.

In addition to the above, on August 4, 2022, SEBI issued a consultation paper on Green and Blue Bonds as a mode of Sustainable Finance aiming to align with the updated GBP by ICMA and seek public comments on the proposed regulatory framework.

The Ministry of Finance rolled out the Sovereign Green Bonds framework (“Framework”) [5] that has been rated “Medium Green”, with a “Good” governance score by a Norway-based independent second opinion provider, the Center for International Climate Research (CICERO). The issuance of sovereign green bonds will help the Government of India with much needed capital and deploy funds from investors in public sector projects. The investors shall not bear any project related risks. The Government of India shall use the proceeds to finance/refinance projects falling under eligible green projects.

The Framework has provided a list of excluded projects, which include nuclear power generation, landfill projects, hydropower plants larger than 25 MW etc. Any expenditure relating to fossil fuels is excluded. The Green Finance Working Committee, constituted by the Ministry of Finance, will assist in the selection and evaluation of projects. The Framework’s publication will provide much-needed clarity and direction to the government’s initiatives aimed at transforming India into a green economy.

Benefits of Investment in Green Bonds

Green bond investments may lead to sustainable development and achieve the climate change goal, benefitting the environment in the future. Green Bonds will lead to increased funding for emerging sectors such as renewable energy since the Reserve Bank of India has included the renewable energy sector as part of its priority sectors. As a result, banks will have to dedicate a specific portion of their lending book to the priority sector. This will help the credit flow in this sector.

As far as commercial viability is concerned, green bonds typically have a lower interest rate than the loans offered by a commercial bank, which helps to reduce the cost for the issuer or promoter.

Challenges Pertaining to Green Bonds

  1. Green Bonds, especially in the Indian context, are still not very popular as there is a lack of structure and framework and uncertainty about the return on investment.
  2. There are no proper rating guidelines for green bonds or green projects to help investors make their investment decisions and to verify companies’ improvements, which directly impacts the development of the green bond market.
  3. The funds that have diversified investments in various sectors may not find investments in the green sector valuable compared to returns in other non-green projects. There have also been instances where, during the running of the Project, the issuer or promoters have faced queries from the authorities about whether the project falls under the green category or not.

Green Finance

India announced at the COP26 Climate Summit that it will increase its efforts to achieve the goal of net zero carbon emissions by 2070, including doubling its non-fossil energy capacity to 500 gigatonnes. [6] However, there has been growth in green financing in India over the last few years in both the public and private sectors.

It appears that the banks and financial institutions in India are not ready for the green transition as the experience in factoring climate change as a risk factor is not there when undertaking credit appraisals.[7] Even the bond market in India is still evolving, which is confirmed by the fact that green bonds have constituted only 0.7% of the overall bond issuance in India since 2018. More initiatives will be needed from a regulatory perspective to make green bond issuance more attractive by bringing measures that make investments in green bonds attractive as compared to other debt securities in India and in international markets.

Furthermore, as the world’s nations, including the developed world, look to India to lead the global transition, India should take the lead in attracting investments in green finance, which will not only benefit individual investors looking for safe instruments with attractive returns, but will also benefit the country in generating investment.

Leveraging a Healthy Green Bond Market in India

To build a healthy green bond market, one of the most important criteria is to achieve international norms, rules and regulations for green bonds along with a reasonable return on investment. Green financing, as an additional source of funding, must be used by companies and investors to establish projects that reduce the risk of climate change. There is an unprecedented demand for green energy globally, and investments through green financing will become inevitable in the long run.

References:

[1] https://efinancemanagement.com/sources-of-finance/green-bonds

[2] https://www.climatebonds.net/market/best-practice-guidelines

[3] https://cdkn.org/story/feature-india-strengthens-credentials-green-bond-issue#:~:text=The%20Axis%20Bank%20bond%20issue,base%20being%20%27green%27%20investors.

[4] https://home.kpmg/xx/en/home/services/advisory/risk-consulting/internal-audit-risk/sustainability-services/first-green-bond-in-india.html

[5] https://dea.gov.in/sites/default/files/Framework%20for%20Sovereign%20Green%20Bonds.pdf

[6] https://www.outlookindia.com/website/story/india-will-achieve-net-zero-carbon-emissions-by-2070-pm-modis-bold-pledge-at-glasgow-un-climate-summit-cop26/399507

[7] https://www.financialexpress.com/opinion/how-to-get-green-financing-to-take-off/2753083/

 

Image Credits: 

Photo by Towfiqu barbhuiya on Unsplash

Green bonds are regular bonds with the distinction that the money raised from the investors must only be used to finance projects that are environmentally friendly. More precisely, green bonds finance projects that are aimed at renewable energy infrastructure, energy-efficient buildings, clean transportation, and waste management.

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Enhancing Business Responsibility of India Inc. Through ESG Disclosures

The global community is negotiating ways to manage climate change and mitigate its impact while ensuring that there is no adverse effect on employment, food security or the living standards of the masses. Addressing climate change is one of the most urgent tasks, particularly for a developing India, which is already bearing the harsh consequences like water shortages, extreme weather events such as floods, coastal erosion, droughts, rising temperatures, anarchical expansion of unregulated industrial growth and other climate affecting events.

On top of it, what is rarely spoken about is another silent killer – fast expansion of concretization, which by itself is a by-product of uncontrolled urbanisation due to the lackadaisical approach of civic agencies. India is decades away from its peak in terms of economic growth and energy consumption, but India’s energy demand is estimated to grow faster than any other country over the next few years. India, a developing country of more than 1.3 billion people, is the world’s third-largest emitter of carbon dioxide after the US and China.

In this background, speaking at the 26th United Nations Climate Change Conference, more commonly referred to as COP26, held in Glasgow in October – November 2021, our hon’ble Prime Minister, Sri. Narendra Modi made five key pledges for how India would decarbonise over the next few decades. He had pledged that India would reach net zero-emissions by 2070.  

 

Broadly, ESG stands for Environmental, Social, and Governance and refers to the three key factors when measuring the sustainability and ethical impact of an investment in any business or industry. The term “environmental” includes carbon emissions, air and water pollution, deforestation, green energy initiatives, waste management, and water usage. The term “social” includes employee gender and diversity, customer satisfaction, corporate sexual harassment policies, human rights at home and abroad, fair labour practices, etc. The term “’governance” includes data protection, privacy, security, transparency, business ethics/values, anti-corruption and anti-bribery policies.

The Financial Times Lexicon defines ESG as “a generic term used in capital markets and used by investors to evaluate corporate behaviour and to determine the future financial performance of companies.” Broadly, the term ESG refers to the examination of a company’s environmental, social, and governance practices, their impacts on the company’s performance, ability to execute its business strategy, create long-term value, and the company’s progress against benchmarks.  

In response to this need, there has been a greater emphasis among investors and stakeholders on businesses that are responsible and sustainable in terms of the environment and society. As such, reporting on a company’s performance on sustainability-related factors has become as vital as reporting on its financial and operational performance. Modern business organisations are now being motivated by more than just profit-oriented strategies and revenue-generating objectives. Sustainability has become an integral aspect of corporate branding and shareholder expectations. ESG, used interchangeably with sustainability based on quantitative or semi-quantitative data, is about pursuing responsible and ethical business practices with attention to social and environmental equity along with economic development. The term “sustainability” is broadly used to indicate programs, initiatives and actions aimed at the preservation of a particular resource. However, it also refers to four distinct areas: human, social, economic and environmental – known as the “four pillars of sustainability”.

The policies adopted by Indian regulators over the past years also indicate that India has made an aggressive move towards decarbonisation to adopt sustainable ways of doing business. India is one of the first countries to demand ‘ethical’ commitments from corporations and industries. In 2013, Corporate Social Responsibility was mandated in India within the Companies Act of 2013, as was suggested in the National Voluntary Guidelines (NVGs) on Social, Environmental and Economic Responsibilities of Business in 2011. The Companies Act, 2013 introduced one of the first ESG disclosure requirements for companies. Section 134(m) mandates companies to include a report by their Board of Directors on conservation of energy with their financial statements and is further detailed under Rule 8(3)(A) of the Companies (Accounts) Rules, 2014, which mandates the board to provide information regarding conservation of energy.

 

SEBI’s Role in Mandating ESG Disclosures

 

There may not yet be any single, comprehensive and stringent enactment governing the entire subject with all checks and balances, but SEBI (Securities and Exchange Board of India) has taken on the role of implementing an efficient ESG policy. As far back in November 2015, SEBI issued a circular prescribing the format for the Business Responsibility Report (BRR) with respect to reporting on ESG parameters by listed entities. The top 500 listed companies in India were instructed by SEBI to disclose indicators of business responsibility and sustainability through Business Responsibility Reporting (BRR). Companies were mandated to include disclosures on opportunities, threats, risks, and concerns as part of their annual reports under Regulation 34(3) of the SEBI (Listing Obligation and Disclosure Requirements) Regulation, 2015 (LODR Regulations).

In 2017, SEBI issued a circular on ‘Disclosure Requirements for Issuance and Listing of Green Debt Securities’ (also known as Green Bonds) to introduce the regulatory framework for the issuance of green debt securities in India and enhance investor confidence. It supplements the SEBI (Issue and Listing of Debt Securities) Regulation, 2008 and envisages a list of disclosures that an issuer must make in its offer document before and after commencement of a project financed by green debt. These additional disclosure requirements have been prescribed to attract the finance reserved for ESG-compliant projects, such as renewable energy and sustainable energy, clean transportation, sustainable water management, climate change adaptation, energy efficiency, sustainable water management, sustainable land use and biodiversity conversion. 

To further strengthen the ESG disclosure regime in India, SEBI amended Regulation 34(2)(f) of the LODR Regulations and on May 10, 2021, SEBI issued another circular detailing new sustainability-related reporting requirements on ESG parameters called the Business Responsibility and Sustainability Report (BRSR) to replace the existing BRR and place India’s sustainability reporting on par with the global reporting standards. The BRSR is intended to have quantitative and standardized disclosures on ESG parameters. Such disclosures will be helpful for investors to make better investment decisions and also enable companies to engage more meaningfully with their stakeholders by encouraging them to look beyond financials and towards social and environmental impacts.

The filing of BRSR after the implementation of new norms has been stipulated as mandatory for the top 1000 listed companies (by market capitalization) for the financial year 2022-23 but voluntary for the financial year 2021-22, to provide the companies with sufficient time to get used to new reporting compliance/regulations. The BRSR seeks continuous disclosures from listed entities on their performance and is aligned with the nine principles of the ‘National Guidelines for Responsible Business Conduct’ (NGBRCs). Adoption of BRSR is yet to pick up pace because of the detailed nature of disclosures required in BRSR. To speed up the process, in a Press Release on May 6, 2022, SEBI constituted an advisory committee on ESG matters in the securities market to create faster momentum.

In respect of non-listed companies however, there is currently no law that mandates that such companies be subject to mandatory ESG disclosure or reporting requirements. However, it can be expected that once the scheme is fully implemented where it is comparatively easier to regulate, it will certainly cover other companies as well as industries in unorganised sectors.

ESG disclosures are highly significant and relevant for all prospective stakeholders involved in business for reasons briefly described as follows.

  • Investors – If a business is not conscious of sustainability, there are chances of it becoming redundant in the future due to legal and regulatory changes prohibiting certain ways of doing business or decreasing demand for business products or deteriorating services. This aspect would certainly motivate the investor’s focus while investing.
  • Businesses – ESG disclosures identify potential transition risks, assess future viability, and take the necessary steps to adapt to likely future changes. Companies that are not aware run the risk of losing profit-making capacity as well as market reputation.
  • Consumers – ESG disclosures also help conscious consumers identify responsible businesses that not only concentrate on profit maximisation but also growth in a responsible manner. Accordingly, the disclosures become part of a marketing strategy to attract more consumers.

ESG goals are a set of standards for a company’s operations that force companies to follow better governance, ethical practices, environment-friendly measures, and social responsibility. They are used by socially conscious investors to screen potential investments. Environmental criteria consider, for example, how a company performs as a steward of nature, safeguards the environment, including corporate policies addressing climate change. Companies with better ESG performance have a better track record on issues such as human rights, climate change, environmental sustainability, social responsibility, ethics, and transparency, and hence are more resilient against future risks. It has become absolutely essential for companies to have comprehensive ESG policies in place.

In conclusion, to quote our Hon’ble Prime Minister, “The decisions taken in Glasgow will safeguard the future of generations to come and give them a safe and prosperous life.”  

The policies adopted by Indian regulators over the past years also indicate that India has made an aggressive move towards decarbonisation to adopt sustainable ways of doing business. India is one of the first countries to demand ‘ethical’ commitments from corporations and industries. 

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Why Businesses Should Focus on ESG?

The world has changed in many fundamental ways especially in the last 25 years. I am not referring to technology-led transformation or geopolitical shifts, this piece is about Environmental, Social and Governance criteria – collectively referred to as “ESG”.

Environmental Criteria

 

Environmental costs, which were for long viewed by economists as “externalities”, are now an important consideration in decision-making by governments and business leaders. Given the devastating effects of widespread environmental degradation and climate change, countries around the world are taking concrete actions to limit further damage; many are setting “net zero” emission targets for individual sectors over the next couple of decades. As a result, new legislations are being enacted that require businesses to act in certain ways and desist from other kinds of actions. Arguably, this is the biggest facet of change globally.

Social Criteria

 

The second area of change is that various forms of social injustice are no longer being tolerated. While there were always rules against such inequities, there is now a greater cost imposed on organizations that violate these rules- not just by governments and regulators, but also by consumers, who choose to shift loyalties towards brands that exhibit greater sensitivity to social causes. By definition, social injustice covers a broad range of issues that includes exploitation of children, women or certain races (e.g., the Uighurs); not providing employees good working conditions (physical environment, denying employees time for bio-breaks and rest, harassment at the workplace etc.); discrimination against people with disabilities, gender, age or marital status; even selling goods that are not safe or bad for health arguably fall under this category.

Governance Criteria

 

The thrust on “governance” is the third major driver of change. It is not as if rules and regulations did not previously exist to prevent breakdowns in governance. Yet, there are a number of examples from around the world that showcase bad governance: from companies in South Korea, Japan, the USA and Europe to the ongoing matters at the NSE and BharatPe in India.

 

Why ESG Adoption is Crucial?

 

In recent years, various members of business ecosystems worldwide, including enterprises, investors, regulators and the general public have become far more aware of the importance of compliance with “ESG” norms and standards. They are much less willing to tolerate breaches in an organization’s “ESG” conduct.

At one level, companies that do not do well on “ESG” parameters are more likely to face explicit financial penalties (e.g., carbon taxes). But just as important are the hidden costs that will increasingly need to be borne by ESG laggards. Perhaps the most important is the reduced access to capital because both banks and PE/VC firms are incorporating ESG criteria into their funding/ portfolio strategies.

On the demand side, many consumers (especially from the younger generations) are more conscious of brands that fare better in terms of their commitment to ESG and this, in turn, shapes their purchase decisions. Brands can quickly lose market share if they do not raise their ESG game.

As shown in the chart below, data over the past decade reveals that companies that have successfully implemented ESG strategies have consistently performed better than other global companies that have not paid as much attention to ESG.

 

Source: Stoxx.com quoted in https://sphera.com/spark/the-importance-of-esg-strategy/

This out-performance can be attributed to a combination of factors, including faster top-line growth, sustained cost reductions, higher employee productivity and reduced employee attrition and of course, fewer instances of fines/penalties for non-compliance. Investment decisions and technology choices that are guided by ESG considerations will drive a more efficient allocation of capital; in turn, this will boost ROCE (Return on Capital Employed).

While it is convenient to look at the three strands of ESG separately, in reality, they are closely intertwined. The sooner business leaders acknowledge that ESG is not a fad or a feel-good factor, but in fact, makes sound business sense, the better it is for the world as a whole.

 

Start Your ESG Journey Right Away

 
Someone quipped that the best time to plant more trees was years ago, but the second-best time is now! It’s not too late for you to begin your ESG transformation. But make sure you do it as a well-structured program, and not merely a hotch-potch of initiatives that have no clear owners, goals or measures and therefore cannot be sustained.

 

To report ESG performance, you can take the help of commonly used frameworks such as the following:

  • UN Sustainable Development Goals (SDGs)
  • Global Reporting Initiative (GRI)
  • Sustainability Accounting Standards Board (SASB)
  • Climate Disclosure Standards Board (CDSB)
  • Task Force on Climate-related Financial Disclosures (TCFD)

Image Credits: Photo by Photo Boards on Unsplash

While it is convenient to look at the three strands of ESG separately, in reality, they are closely intertwined. The sooner business leaders acknowledge that ESG is not a fad or a feel-good factor, but in fact, makes sound business sense, the better it is for the world as a whole.

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Intensifying Social Accountability of Corporates in India

In a bid to make companies progressively accountable in the social panorama, the government has been modifying the provisions of Corporate Social Responsibility (“CSR”) ever since its introduction. Amendments have been made in section 135 of the Companies Act, 2013 (“the Act”), The Companies (Corporate Social Responsibility) Rules (“the Rules”) and Schedule VII (“Schedule”) of the Act by the Ministry of Corporate Affairs (“MCA”), from time to time.

While the earlier amendments to section 135 of the Act and the Rules were mostly clarificatory in nature or were relating to the inclusion of certain activities relating to COVID – 19 as the contribution made towards  CSR, the amendments to section 135 of the Act inserted by the Companies (Amendment) Act, 2019 and the Companies (Amendment) Act, 2020 and notification of The Companies (Corporate Social Responsibility) Amendment Rules, 2021 (“the Amended Rules”), both effective from January 22, 2021, has brought about a radical change in the treatment of unspent CSR amount, among other amendments, which is dealt with in this write-up.

  1. CSR applicability extended to newly incorporated companies as well:

Sub-section (5) of section 135 provides that every company crossing the threshold limits prescribed in section 135(1) has to necessarily spend at least 2% (two percent) of the average net profits of the company made during the immediately preceding three financial years. By way of inclusion to section 135 (5), newly incorporated companies that cross the threshold limits prescribed under section 135(1) of the Act have also been brought within the ambit of compliance with CSR provisions.

  1. Compliance in respect of unspent CSR amount:

A brief outline of the amendments relating to the treatment of unspent amount is provided below:

 

  1. Penalty for non-compliance of sub-sections (5) or (6) of section 135 of the Act:

The newly-inserted sub-section (7) of section 135 of the Act deals with a penalty for non-compliance of provisions of sub-section (5) or (6). It is pertinent to note that the provisions of Companies (Amendment) Act, 2019 had prescribed for imprisonment for a term extending to three years, apart from a fine that may be imposed, on the failure of a company to comply with the provisions of sub-sections (5) or (6) which relates to transfer of unspent amount other than ongoing project and transfer of amount towards ongoing project respectively.

Understandably, there were apprehensions over the proposed implementation of penal provision with imprisonment for CSR activity, and after deliberations, the provision was replaced with a provision in the Companies (Amendment) Act, 2020 which provides only for penalty without imprisonment for non-compliance of sub-section (5) or (6) of section 135 of the Act.

Penalty for the company – twice the amount required to be transferred by the company to the Fund specified in Schedule VII / unspent CSR account (or)

INR 1,00,00,000/- (Indian Rupees One Crore only), whichever is less.

Penalty for every officer of the company who is in default –

one-tenth of the amount required to be transferred by the company to such Fund specified in Schedule VII / unspent CSR account (or) INR 2,00,000/- (Indian Rupees Two Lakhs only), whichever is less.

  1. Power to give general or special directions:

As per sub-section (8) which has been inserted, the Central Government may give general or specific directions to a company or a class of companies, as necessary, which are required to be followed by such company/class of companies.

  1. Constitution of CSR Committee:

CSR committee is not required to be constituted by a company, where the amount it has to spend towards CSR activities is not more than INR 50,00,000/- (Indian Rupees Fifty Lakhs only) and the functions of the CSR committee shall be discharged by the Board of Directors of the company.

  1. Other notable changes in Amended Rules:
  • Registration under sections 12A and 80G of the Income Tax Act, 1961 has been made mandatory for CSR implementation entities (Rule 4(1) of the Amended Rules).
  • Every CSR implementation entity has to file Form CSR – 1 and obtain CSR registration number compulsorily from April 01, 2021 (Rule 4(2) of the Amended Rules).
  • Chief Financial Officer or any person responsible for financial management shall certify that the funds disbursed have been utilized for the purposes and manner as approved by the Board (Rule 4(5) of the Amended Rules).
  • In case of ongoing project(s), the Board shall monitor its implementation and shall make necessary modifications, as required (Rule 4(6) of the Amended Rules).
  • The CSR Committee shall formulate and recommend an annual action plan in pursuance of its CSR policy to the Board comprising the particulars as specified in Rule 5(2) of the Amended Rules, which may be altered at any time during the financial year, based on a reasonable justification.
  • Surplus earned from CSR activities shall be ploughed back into the same project or transferred to the “unspent CSR account” and spent as per the CSR policy and annual action plan or shall be transferred to the Fund specified in Schedule VII of the Act but shall not form part of the business profit of a company (Rule 7(2) of the Amended Rules).
  • The CSR amount may be spent by a company for the creation or acquisition of a capital asset, which shall be held by a CSR implementation entity specified in Rule 4, which has CSR registration number, or beneficiaries of the CSR project or a public authority (Rule 7(4) of the Amended Rules).
  • Annual report on CSR to be in the format specified in Annexure-II of the Rules, in respect of board’s report for the financial year commencing on or after April 01, 2020 (Rule 8 (1) of the Amended Rules).
  • Companies having an average CSR obligation of INR 10,00,00,000/- (Indian Rupees Ten Crores only) or more in the three immediately preceding financial years has to undertake an impact assessment of CSR projects, having an expenditure of INR 1,00,00,000/- (Indian Rupees One Crore only) or more and which have been completed not less than one year before undertaking the impact study, through an independent agency (Rule 8(3) of the Amended Rules).

Ambiguities in the recent amendments:

  1. Whether unspent amounts of previous years have to be transferred?

Although, it has been specifically provided in some of the Amended Rules (viz., implementation of CSR provisions through specified entities, reporting of CSR as provided in Annexure provided in the Amended Rules) that the said amendments are applicable on or after April 01, 2021, the time period from which the provisions relating to the transfer of unspent CSR amount to “unspent CSR account” / Fund is applicable, i.e. whether the unspent CSR amounts relating to the past financial years (from the date of applicability of the CSR provisions to the company) are required to be transferred to the “unspent CSR account” / Fund or only the CSR amount remaining unspent as on March 31, 2021, has to be transferred, has not been explicitly provided in the Act or the Amended Rules.

  1. Whether the outstanding amount of provision created for the unspent amount must be transferred?

The amended provisions do not stipulate whether unspent CSR amounts of the previous financial years have to be transferred to the designated account / Fund in case a company has created a provision in the books of accounts for such unspent amount for the relevant financial years.

The foregoing matters require suitable redressal by the MCA in the form of clarifications or FAQs or amendments to the existing provisions, which will offer a much-needed clarity on these matters.

Conclusion:

With the recent amendments, the CSR provisions have undergone a paradigm shift from “Comply or Explain” to “Comply or Pay” regime as they provide for penalties on failure to transfer unspent CSR amount to the specified account / Fund, whereas earlier, providing reasons for not spending CSR amount was considered adequate compliance. Hence, the said amendments have placed additional responsibilities on corporates.  Having introduced the concept of penalty, it is only appropriate that the MCA addresses the obscurities arising from the amendments at the earliest so that corporates are not caught off-guard in complying with the CSR provisions.

Image Credits: Photo by Tim Marshall on Unsplash

the CSR provisions have undergone a paradigm shift from “Comply or Explain” to “Comply or Pay” regime as they provide for penalties on failure to transfer unspent CSR amount to the specified account / Fund, whereas earlier, providing reasons for not spending CSR amount was considered adequate compliance.

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Corporate Social Responsibility (CSR) during Covid-19

The novel coronavirus (“COVID-19”) was declared as a pandemic by the World Health Organization on March 11th, 2020 and subsequently, the Government of India decided to treat it as a notified disaster.  Accordingly, the Government took various steps to curb the spread of the disease as well as minimize the impact on the economy. While businesses were grappling with the new reality of this global uncertainty, their support and participation was considered imperative to manage the current situation. To encourage entities and garner their cooperation, the Government decided to treat funds spent on activities relating to COVID-19 as part of CSR performance. Additionally, the Ministry of Home Affairs of India issued directions to lockdown all the states in India till 20.05.2020 (“Lockdown Period”) and has come up with various notifications with respect to payment of salaries/ wages to employees.

Under section 135 of the Companies Act, 2013 (“Act”), every company having a net worth of Rs. 500 Crores or more, or turnover of Rs. 1000 Crores or more or a net profit of Rs. 5 Crores or more during the preceding financial year shall constitute a CSR Committee. This CSR Committee shall formulate and recommend a CSR policy for the activities to be undertaken by the company, recommend the amount of expenditure to be incurred on the activities and monitor the CSR policy of the company from time to time. The company shall spend, in every financial year, at least 2% of its average net profits made during three immediately preceding financial years or since incorporation, whichever is applicable. Moreover, the CSR expenditure shall include projects and programs specified under Schedule VII of the Act.

Keeping in mind the requirement under the Act, the Ministry of Corporate Affairs (“MCA”) issued a General Circular No. 10/2020 dated 23.03.2020 (“General Circular”) on the spending of CSR funds for COVID-19. The MCA has clarified that spending of CSR funds for COVID-19 is an eligible CSR activity. The MCA through the General Circular has included the promotion of health care including preventive health care and sanitation, and disaster management to the list of CSR activities under Schedule VII. Furthermore, it is pertinent to note here that as per General Circular No. 21/2014 dated 18.06.2014 issued by MCA, the entries in Schedule VII are broad-based and must be interpreted liberally so as to capture the essence of the subjects therein. With this change, Schedule VII now recognizes any contribution to incubators funded by Central or State Government or any Government agency engaged in conducting research in science, technology, engineering, and medicine as falling within the ambit of CSR. 

Moreover, the Government of India has set up a public charitable trust under the name of Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund (“PM CARES Fund”) to deal with any kind of emergency or distress situation, like the one posed by the COVID-19 pandemic. In view of this, the MCA issued Office Memorandum F. No. CSR-05/1/2020-CSR-MCA dated 28.03.2020 which provides that any contribution made to the PM CARES Fund shall qualify as CSR expenditure under item No. (viii) of the Schedule VII of the Act, which reads as under:

“(viii) contribution to the prime minister’s national relief fund or any other fund set up by the central govt. for socio-economic development and relief and welfare of the schedule caste, tribes, other backward classes, minorities and women”

The MCA issued further clarifications vide General Circular No. 15/ 2020 dated 10.04.2020 (“New Circular”) due to several queries on the eligibility of CSR expenditure related to COVID-19 activities. The following are the clarifications issued in the New Circular:

  1. The contribution made to the PM CARES Fund shall qualify as CSR expenditure under item no. (viii) of Schedule VII of the Act as stated above.
  2. Any contribution to ‘Chief Minister’s Relief Fund’ or ‘State Relief Fund for COVID-19’ is not included in Schedule VII of the Act and therefore, it shall not qualify as CSR expenditure.
  3. As provided in the General Circular, contribution made to State Disaster Management Authority to combat COVID-19 shall qualify as CSR expenditure under item no. (xii) of Schedule VII of the Act which reads as under:

“(xii) disaster management, including relief, rehabilitation and reconstruction activities”

  1. Funds spent on various activities related to COVID-19 under the items of Schedule VII with respect to the promotion of health care including preventive health care, sanitation, and disaster management shall qualify as CSR expenditure.
  2. The payment of salary/wages to employees and workers during the lockdown period is a moral obligation of the employers, as they have no alternative source of employment or livelihood during this Lockdown Period. Therefore, payment of salary/wages to the employees and workers during the Lockdown Period shall not qualify as admissible CSR expenditure. Moreover, payment of wages to temporary or casual, or daily wage workers during the Lockdown Period shall also not count as CSR expenditure as this forms a part of the contractual or moral obligation of the company and is applicable to all companies irrespective of whether they have any legal obligation for CSR contribution under section 135 of the Act.
  3. In case of any ex-gratia payment made to temporary/ casual workers/ daily wage workers over and above the payment of wages, specifically for the purpose of fighting COVID-19, the same shall be considered CSR expenditure. It is pertinent to point out that this payment shall be admissible as a one-time exception provided there is an explicit declaration to that effect by the Board of the company, which is duly certified by the statutory auditors.

 

To sum it up, the MCA has clarified that the expenses made by the corporate entities with regard to COVID-19 shall be construed to be part of the CSR responsibilities under the Companies Act, 2013 if the activities and expenses include the following:

  1. Contribution to PM CARES Fund;
  2. The contribution made to State Disaster Management Authority; and
  3. Funds spent on activities relating to the promotion of health care including preventive health care, sanitation, and disaster management.

Further, to put rest to the discussions pertaining to payment of salaries and wages to the employees or contract workers, the MCA has also clarified that payment of salaries and wages are moral obligations of a company irrespective of the CSR contribution. Therefore, payment of salaries and wages do not form part of CSR expenditure. However, MCA has provided a one-time exception for ex-gratia payment to the temporary or casual workers for fighting COVID-19.      

Corporates are opting for a hybrid approach where they are partly contributing to the various funds and simultaneously directly getting involved in the process of fighting the disease by manufacturing equipment, making quarantine facilities, and distributing free rations. The key here is to fight the disease from all possible fronts with the help of all possible avenues. Corporates taking an active part reflects their values and shall positively impact their reputation management efforts. However, had the payment of wages been included in the CSR activity, employees who are losing their job could see some respite. That said, the one-time exception for temporary and casual workers is definitely a positive step that goes a long way in resolving the economic distress that is affecting individuals and businesses alike.

ACTIVITY

COUNTS AS CSR?

Contribution to PM CARES

Yes

Contribution to State Disaster Management Authority

Yes

Payment of Salaries/Wages

No

Ex-Gratia Payment Above Wages to Temporary/Casual Workers for Fighting COVID-19

Yes, One Time

COVID-19 Related Activities Under Schedule-VII

Yes

Contribution to Chief Minister Relief Fund

No

Contribution to State Relief Fund for COVID-19’

No

 

 

Image Credits:  Photo by cottonbro from Pexels

Such measures from the Government will certainly create a positive sentiment and a sense of tax certainty amongst the investors and hopefully, help in attracting incremental foreign investment into the country, that will play an important role in promoting faster economic growth and development.

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