Environmental, social and governance (ESG) compliances have today become important for organisations of all types. Experts assert that Indian businesses will increasingly face environmental, social and governance risks. Mumbai-based ESGRisk.ai, a wholly-owned subsidiary of Acuité Ratings & Research Limited, is India’s first ESG rating company with an India-specific assessment framework. In an interview with ET Online, Sankar Chakraborti, Chairman ESGRisk.ai and Group CEO of Acuité, talks about the need for rigorous due diligence as financial institutions’ lending ticket size to MSMEs grow. He highlights the need for MSMEs to establish systems and processes, specifically focusing on managing the “G” or governance aspect of the ESG approach. Edited excerpts:
ET: Given the rise in lending to MSMEs, financial institutions are expected to ramp up due diligence measures. Are MSMEs prepared for such due diligence?Sankar Chakraborti (SC): Indian MSMEs are not prepared because most MSMEs are not financially educated and lack professional resources to manage finances. As a result, they lack an understanding of how lending decisions are taken at banks or other financial institutions. So, imparting financial education is of utmost importance for MSMEs. This is where ratings come into play.
Ratings allow them to understand how banks look at potential borrowers (in this case the MSMEs), which in turn helps them to improve their performance in such a manner that they can present their due diligence in a better way.
ET: Studies show organisations, especially MSMEs, have fallen short on the governance aspect of ESG. How does financial transparency impact the relationship between lenders and MSME borrowers in terms of ESG compliance, and what challenges does this present?
SC:
Transparency in financials is critical for building trust between the lender and borrower. There is a strong perception among lenders that the financials of MSMEs cannot be entirely trusted, making it a core reason that banks are not able to lend to MSMEs if they find there are issues with their financials.
Often, MSMEs may have a history of non-sincere debt repayments or take shortcuts to secure loans, which leads to scepticism among lenders. These factors are very critical for MSMEs to secure lending from banks and other institutions.
ET: What are the processes and systems that SMEs should be focused on to ensure governance standards are maintained when fresh funding is acquired?
SC:
I believe technology is one aspect that can help SMEs bridge the gaps in securing lending. SMEs can start this upgrade by implementing ERP or other reliable accounting software and enhancing governance practices.
There should also be some attempt to steer clear of the lure of creatively enhancing their profits or revenues. Adopt industry best practices in terms of ownership structure and strengthening their board structure. These are a few steps that can help secure institutional lending at favourable terms.
ET: SMEs are seen to be lagging when compared with large-cap companies in having systems and processes to mitigate ESG risk. Is this one reason for their low rating in the ESG space? What can SMEs do to have higher ratings, especially in the governance space?
SC: Fundamentally, we set off on the wrong foot as soon as we compare MSMEs with large companies. The level of systems and processes an entity implements depends on how much resources the entity possesses. Large companies are better off in terms of financial and other resources and so are in a better position to mitigate risk.
MSMEs should be compared with other MSMEs and not large corporates. Only then will the benchmarking or the comparison be meaningful. This is the methodology we adopt at SMERA for SME Ratings and other offerings. This is also one of the core differentiators of SMERA Ratings from other ratings, where we benchmark SMEs’ credibility, which is specific to SMEs.
ET: Following the new 45-day payment ruling, corporates and MSMEs are making representations to the government to defer or modify the rule. How can there be a sound ecosystem through ideal governance practices, such that corporates can comfortably make payments and MSMEs can receive timely payments?
SC: The government would not have resorted to this new ruling had the problem of delayed payments not haunted businesses. Here, a quote from the Spider-Man movie resonates the most: ‘With great power comes great responsibilities’. Large corporations have great powers in terms of the level of resources they possess and the kind of impact they can create. These great powers demand greater responsibilities from them in terms of uplifting the economy, be it through their employment generation capabilities or CSR activities or simply by doing business in the right spirit, which mandates making timely payments to the vendors (in this case, the MSMEs).
It is a matter of perspective, and I think the markets should take this initiative positively, where larger players support the MSMEs in terms of resource mobilisation and MSMEs, in turn, provide quality offerings. Both parties respect each other with timely supplies and payments, thus mitigating the risk associated with governance both for MSMEs and large corporates.
