ESG

ESG stands for Environmental, Social and Governance. The workbook calls it a generic term for judging how companies behave. People use it in place of words like sustainable, responsible, impact or ethical investment.

The workbook says ESG is a fast-growing way to invest, especially in alternative investing. It is also shaping, step by step, how businesses should work. The case for it is practical as much as moral. Investors can back companies that meet ESG standards. By doing so, they help build a world of responsible businesses. Those businesses then draw the right investors, staff and customers.

For a Category III AIF, ESG shows up in three real places. The first is the Stewardship Code that SEBI applies to AIFs' investments in listed shares. The second is the risks reported to investors every quarter. The third is the due diligence that big institutional investors run on the fund itself.

Background (3.3.5)

• The UN-backed Principles for Responsible Investment (PRI), launched in 2006, is a global investor network integrating ESG into investment practice, on the view that ESG can affect portfolio performance and belongs alongside traditional financial factors in fulfilling fiduciary duty. Indian fund houses becoming signatories include Kotak, SBI and Avendus.
• ESG indices began in the US in the early 1990s — the MSCI KLD 400 Social Index in 1990. In India they debuted in 2012.

SEBI Stewardship Code — for all categories of AIFs, for investments in listed equity (circular of 24 December 2019):

1. Formulate, disclose and periodically review a stewardship policy.
2. Have and disclose a policy on managing conflicts of interest in stewardship.
3. Monitor investee companies.
4. Have a policy on intervention in investee companies, and on collaboration with other institutional investors.
5. Have a policy on voting and disclosure of voting activity.
6. Report periodically on stewardship activities.

Stewardship covers monitoring and engaging with investee companies on performance, risk, strategy, governance, board structure, remuneration and material ESG opportunities and risks. Chapter 6 adds that AIFs must follow the Code from FY 2020-21, with adequate internal controls and periodic reports to SEBI and clients.

Quarterly risk reporting. Within 60 days of each quarter end, a Category III AIF reports material risks to investors — including extra-financial risks, including ESG risk, at fund and investee company levels.

Due diligence (7.5). Institutional investors review a fund's ESG policies — workplace safety and professionalism, and governance such as timely disclosures, regular investment committee meetings and independent directors.

Illustrative figures. Kaveri Responsible Equity Fund, a Category III AIF, holds Rs 250 crore of listed Indian equities. One position — Rs 20 crore in a chemicals company — is hit by a regulator's order over effluent discharge.

Exposure = Rs 20 crore ÷ Rs 250 crore = 8% of the listed portfolio

What the Stewardship Code asks of the manager

Quarterly reporting. For the quarter ended 30 June 2026, the fund must report material risks — including this ESG risk at investee-company level — within 60 days:

31 days (July) + 29 days (August) = 60 days → by 29 August 2026

A pension fund considering Kaveri later asks, in due diligence, for its ESG policy and its record of timely disclosures and investment committee meetings. A weak answer would, in the workbook's words, give a bad signal to potential institutional clients.

Chapter 3 (Introduction to the Category III AIF Ecosystem) defines ESG at 3.3.5, with PRI, ESG indices and the Stewardship Code, and lists ESG risk among material risks in 3.7. Chapter 5 requires quarterly reporting of extra-financial including ESG risks. Chapter 6 lists ESG risk among Category III risk factors and dates the Stewardship Code obligation, and Chapter 7 includes ESG policies in investor due diligence.

• ESG is a generic term used interchangeably with sustainable, responsible, impact or ethical investment.
• PRI: UN-backed, launched 2006. US ESG indices: early 1990s (MSCI KLD 400 Social Index, 1990); India: 2012.
• The Stewardship Code applies to AIFs' investments in listed equities, and must be followed from FY 2020-21.
• Five or six principles? The workbook contradicts itself. Section 3.3.5 says the Stewardship Code "is based on the following five principles" and then lists six, the sixth being periodic reporting on stewardship activities. Learn all six.
• ESG risk is reported quarterly within 60 days, as an extra-financial risk at both fund and investee company levels.
• Governance in due diligence means the fund's own governance too — disclosures, committee meetings, independent directors — not only investee companies.