Governance at CPSEs: An ESG rating dampener; will it improve?

India’s central public sector enterprises (CPSEs) have been at the lower end of governance scores due to delays by the government in the appointment of independent directors (IDs), leading to a 66 percent fall in their count in FY19-1HFY22, noted brokerage firm CLSA.

This is severe on CPSEs, as they have little control over the appointment of IDs, being coordinated by line ministries and over-regulation of the business from a minority perspective.

CLSA noted that this delay cost the Power Grid Corp of India Ltd (PWGR) a one-notch ESG (Environmental, Social, and Governance) rating downgrade and a lack of an upgrade for NTPC despite commendable actions on energy transition.

Better governance leads to better valuations in the ESG-driven world; that is good for government divestment programs as well.

While the Modi government has been at the forefront of improving ease of doing business and governance, one thing that seems to have missed their attention is simplifying the lengthy process of appointment of IDs on the CPSE boards.

Our deep dive into 57 CPSEs revealed that not only the count of IDs has fallen 66 percent for FY19-1HFY22, its share of the boards also fell to 21 percent in 1HFY22 vs 44 percent in FY19. This will likely limit their ability to have independent committees as well.

In a world where investments are increasingly driven by ESG frameworks, the current situation of CPSE boards is untenable and needs urgent fixes or capital will move towards the private sector, which is far more agile in adapting to ESG frameworks.

Performing CPSEs had their MSCI ESG ratings cut due to weak governance ie, lack of IDs, such as at Power Grid, or their score has not improved in line with their work on environmental factors such as at NTPC.

As per Regulation 17(1) of SEBI’s Listing Obligations and Disclosure Requirements, at least 50 percent of the board should comprise IDs if a company has an executive chairperson; 33 percent of the board should be IDs if the chairperson is non-executive.

The situation of IDs is equally worrisome for non-banking and banking sectors, with IDs being 20 percent and 23 percent at end-September 21.

However, a CNBC-TV18 check suggests the tide is turning now, with the government getting back to business. We see NTPC, PWGR and IOC as key beneficiaries.

A CNBC-TV18 check revealed that the government is getting back to business. The appointments committee of the cabinet has begun to process the appointment of IDs.

While the damage may have been done to key CPSEs getting poor ESG ratings in 2021 due to weak governance scores, the likely appointment of IDs in the next 12 months could benefit NTPC, PWGR and IOC. The key is to reach 50 percent IDs by September 22.