SEBI mulls tighter regulation norms for ESG rating providers, eyes 'Parivartan' of firms

Given the increasing currency of ESG ratings, the role played by ERPs has assumed outsized importance.

The Securities and Exchange Board of India (SEBI) has pitched for an enforceable regulatory and supervisory framework for ESG Rating Providers (ERPs), which, if implemented, will set fetters on the kind of business model that can be adopted by ERPs but will simultaneously "mitigate potential conflict of interests."

The paper pitches that ERPs be permitted to adopt either a issuer-pays or a subscriber-pays business model. However, a hybrid model, where the ERP assigns ESG rating to one firm on the basis of the issuer-pays model and to another on the basis of the subscriber-pays model has been turned down in the paper.

"The above proposal is to mitigate potential conflict of interests. An investor may rely on a certain ERP based on the assumption that the ERP assigns a rating based on a subscriber-pays business model. However, the ERP might be assigning another ESG rating (or type of ESG rating) to the same company (or a group company) under an issuer-pays business model" the paper states.

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ESG ratings have of late come into vogue and a growing community of investors put stock in assessing the ESG (Environmental, Social and Governance) norms embraced by a firm as a parameter to be considered before pooling investments into it. Given the increasing currency of ESG ratings, the role played by ERPs has assumed outsized importance.

"However, since the activities of ERPs are typically not subject to regulatory or supervisory oversight at present, increasing reliance on such unregulated services in the securities markets raises concerns about the potential risks it poses to investor protection, the efficiency of markets, risk pricing, capital allocation and greenwashing, among others," the regulator said in the consultation paper.

In May last year, the market regulator constituted an advisory committee on ESG issues under whose aegis ESG disclosures, ESG investing and ESG ratings were deliberated in an integrated manner. Based on the recommendations of the committee, and another consultation paper on ESG disclosures, the ERPs may provide a Core ESG rating based on assured indicators.

It has been further proposed that while Core ESG ratings must necessarily be based on assured or verified data, ERPs may be allowed to provide additional commentary/outlook/observations on data that may not be verified or assured.

"For instance, an unverified controversy must not be factored in the Core ESG rating/score. However, ERPs shall have the discretion to provide a commentary on the same, if they so desire." the paper lays down.

The ERPs have also been advised to provide two additional ratings, namely, an ESG transition or a Parivartan score. The Parivartan score will measure a firm's velocity of investments in making the transition to Net Zero Goals and improvements in its ESG risk management. Secondly, ERPs will rate companies on 'combined scores' which will measure companies on ESG rating and transition rating, i.e. their current status and the ability to transition.