The increasing importance of ESG-related issues and their potential impact on the long-term performance of companies has led to growing interest from stakeholders, including investors and financial regulators. ESG Rating Providers (ERPs) play an important role in making investment decisions, but their activities are not currently subject to regulatory or supervisory oversight, raising concerns about potential risks to investor protection, market efficiency, risk pricing, capital allocation, and greenwashing. Regulators in various jurisdictions, including SEBI in India, have proposed regulations and accreditation for ERPs to address these concerns. Other international bodies such as IOSCO are also taking measures to increase scrutiny over providers of ESG ratings.
Regulatory provisions
SEBI proposes to introduce a regulatory framework for ESG Rating Providers (ERPs) and suggests they register under the SEBI (Credit Rating Agencies) Regulations, 1999. SEBI proposes an enforceable regulatory and supervisory framework for ERPs to protect the interest of investors in the securities market, while also attempting to follow a principles-based approach and allow for further innovation. SEBI recommends that ERPs form an industry association and play an active role in the development of a regulatory framework for ERPs in the Indian securities market and engage with SEBI at its EAC.
Rating rationale
The committee’s terms of reference for ESG ratings were to develop a separate approach for emerging markets, uniform indicators for “G,” and disclosures in the rationale by ESG rating providers. Based on the committee’s recommendations and internal deliberations, SEBI proposed an additional type of ESG rating based on BRSR Core framework. SEBI suggested that ERPs may provide a Core ESG rating based on assured indicators, and they may also give an additional commentary or observations on data that are not verified or assured.
Disclosures
ESG rating providers use subscription-based or issuer-pays business models to assign ESG ratings to entities. To ensure transparency in the ESG rating process and help stakeholders understand the assigned rating, it is proposed that ESG rating rationale or report should contain minimum disclosures like current ESG rating/score, change in rating/score from previous evaluation, last review date, summary of key drivers (both qualitative and quantitative factors), and pillar-wise E, S, and G scores with key drivers (including industry comparisonsof material parameters).
Transition/Parivartan score
The paper suggests that Indian companies should be evaluated on their transition to sustainable operations in addition to their current ESG ratings. Two additional ratings are proposed: ESG transition/Parivartan score, measuring a company’s progress in transitioning to more sustainable operations, and a combined score that considers both ESG rating and transition rating. It recommends a comprehensive framework that considers aspects beyond revenue generation for measuring transition scores. Lastly, two ways of providing a combined score are suggested:
- ESG Score + Transition or Parivartan Score = Combined Score,
- Core ESG Score + Core Transition or Parivartan Score = Core Combined Score.
Note: The “+” sign does not mean simple addition of the two scores, but rather a combination of the two scores, as per the publicly disclosed methodology of the ERP.
Business Model
It is proposed that ERPs in India can use either an issuer-pays or a subscriber-pays business model, but hybrid models are not allowed to avoid potential conflicts of interest. An ERP cannot assign different ESG ratings to the same company or group company under different business models. The aim is to ensure transparency and consistency in ESG ratings for investors.