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7 March 2025

Dawn Of The SEBI - Certified ESG Rating Firms: Bridging The Gap Between Governance And Sustainable Investment

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Legacy Law Offices

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Legacy Law Offices LLP is a multi-disciplinary law firm with a diversified portfolio of professional legal services. The firm has offices in New Delhi, Chandigarh, Solan and Kurukshetra with an associate office in Mumbai as well as a representative office in the Kingdom of Saudi Arabia. Lawyers of the firm provide legal services across India and have worked on various developmental projects across countries in SAR, CAREC, MENA, and Africa. Legacy Law Offices LLP is also empanelled with the PPP authority of Bangladesh. The law firm is acknowledged as a "Leading Law Firm" by various leading global legal directories, including Legal500 and IFLR1000
As the global financial markets undergo a seismic shift towards sustainable investments and finance, Environmental, Social, and Governance (ESG) considerations have evolved from a peripheral concern to a defining pillar in corporate strategy built on sustainable and responsible business practices.
India Corporate/Commercial Law

Introduction

As the global financial markets undergo a seismic shift towards sustainable investments and finance, Environmental, Social, and Governance (ESG) considerations have evolved from a peripheral concern to a defining pillar in corporate strategy built on sustainable and responsible business practices. Today, ESG is no longer a choice or a mere checkbox for the sake of compliance- it is turning into an indispensable element of businesses of the modern day, serving as an indicator of systemic risk mitigation and long-term financial resilience, shaping investment decisions and corporate governance. However, despite the increase in ESG-driven investments in the market, concerns over inconsistent reporting frameworks, green washing, and data opacity questions the credibility of ESG ratings, which calls for a regulatory intervention.

In India, the legal and regulatory framework landscape has evolved steadily to integrate ESG principles into corporate governance, driven by specific regulations such as the Companies Act of 2013, SEBI Listing Regulations (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR), and Indian Banks Association (IBA) rules, that reinforces corporate responsibility and sustainability mandates. The introduction of the Business Responsibility and Sustainability Reporting (BRSR) framework further institutionalises ESG reporting, a basis for reporting on ESG factors and integration of responsible business practices into the country's corporations. These initiatives reflect India's alignment with global sustainability standards and its commitment to promote ethical investments and corporate accountability.

Unlike the traditional Corporate Social Responsibility (CSR) initiatives, often centred on corporate branding and philanthropy, ESG assessment techniques used in India move beyond philanthropy or corporate branding to focus on hard quantifiable figures and structured reporting. Such shift reflects transparency and promotes reliability, addressing issues of greenwashing and provides the investors with a more holistic approach to evaluate long-term sustainability difficulties and financial resilience.

With investors and stakeholders increasingly prioritising sustainability and other ethical considerations, ESG ratings1 have emerged as an effective tool for assessing an organisation's robustness against future shocks, effective risk management and the possibility of generating long-term sustainable earnings. In an attempt to regulate the ESG Rating Industries in the country, the Securities Exchange Board of India (SEBI) introduced a comprehensive regulatory guideline for the Environmental, Social, and Governance Rating Providers (ERPs), thereby granting more credibility, transparency and standardisation to the ESG rating industry. This regulatory intervention by the Indian Securities Market regulator, SEBI, stands out as it aligns India's ESG ecosystem with global best practices by strengthening assessments for corporate sustainability and reducing market distortions caused by unreliable ESG scores.

Need for ESG Ratings Regulations: A Game Changer

With the growing concerns about sustainability, ESG ratings have emerged as an essential tool for evaluating corporate practices. The International Organization of Securities Commissions (IOSCO) Consultation Report defines ESG ratings as "the broad spectrum of rating products in sustainable finance and includes ESG scoring and ESG rankings." These ratings provide the investors with an opinion as to how well the companies are managing their ESG-related risks and opportunities.

In the Indian context,2 SEBI has attempted to define its own, broadening the scope of ESG ratings to align with international standards.

According to SEBI3, "Environmental, Social, and Governance ratings", or "ESG ratings" refer to the broad spectrum of ratings products that are marketed as providing an opinion regarding an entity that is listed or proposed to be listed on a stock exchange recognized by the Board, or a security, that is listed or proposed to be listed on a stock exchange recognized by the Board, about its ESG profile or characteristics or exposure to ESG, governance risk, social risk, climatic or environmental risks or impact on society, climate and the environment, that are issued using a defined ranking system of rating categories, whether or not these are explicitly labelled as ESG ratings."

Key characteristics of ESG ratings, as per the definition, are:

  1. ESG ratings can be either "entity-specific" or "security-specific," meaning that such ratings may provide an opinion either about an entity or a security that is listed or proposed to be listed on a recognized stock exchange in India.
  2. ESG ratings can be classified as either 'risk' ratings or 'impact' ratings as they provide an opinion on the ESG profile or characteristics of an entity or security, and may refer to the ESG risks faced by the entity or the impact it may have on the environment and society, or both.
  3. ESG ratings must be issued using a defined ranking system of rating categories.
  4. Lastly, it is important to note that an opinion shall qualify as an ESG rating irrespective of the existence or absence of an explicit label of "ESG ratings"

SEBIs Regulatory Framework for ESG Rating Providers (ERPs)

SEBI4, in a landmark move, has recently approved a regulatory framework for ESG Rating Providers (ERPs)5 in India, proposing amendments to the existing SEBI (Credit Rating Agencies) Regulations to include a new chapter dedicated to ERPs. The framework6 outlines eligibility criteria, categories of ERPs, transparency and disclosure norms, and measures to address potential conflicts of interest. 7

The two proposed categories of ERPs are:

Category I with higher net worth requirements and eligibility to certify green debt securities, and

Category II with lower entry barriers but restricted from certifying green debt securities.

In addition to this, transparency and disclosure requirements for ERPs include publishing methodologies, weightages, change in ratings, and evaluation reports on their websites. Measures to mitigate conflicts of interest include restrictions on cross-holdings, board representations, and rating entities with certain relationships.

The International Organization of Securities Commissions (IOSCO)8 has also issued recommendations for good practices, urging asset managers to develop policies and disclosures related to sustainability risks and opportunities, and ERPs to ensure high-quality ratings, transparency, and conflict management.

These regulatory developments aim to align the Indian ESG rating industry with global standards of sustainable finance practices and investor protection, bringing credibility, transparency, and standardisation to the ESG rating industry.

Comparative Lens: ESG Disclosures in the European Union & India

In India, the Business Responsibility and Sustainability Report (BRSR) framework9, has been made mandatory by the Securities and Exchange Board of India (SEBI) for the listed companies to disclose ESG information on the basis of their operation size. It is also worthy to note here that, this framework applies specifically for the 1000 largest listed companies and companies with NAV of INR 1000 crores and above. It also comprises of disclosures on governance, stakeholder engagements, and environmental impact.10

On the other hand, the EU11 mandates on non-financial reporting through the Non-Financial Reporting Directive (NFRD) for large public-interest entities with 500+ employees, expanded to 50+ employees under corporate Sustainability Reporting Directive (CSRD) and compels them to disclose information concerning environment, social, employment, human right, anti-corruption and bribery policies, threats, and enactments. Moreover, the EU Taxonomy Regulation is becoming significant in classifying sustainable economic activities

< In terms of the disclosure standards, the BRSR framework implemented on the Indian companies requires the management to disclose certain ESG parameters and factors such as energy consumption, emissions, social impact, diversity, and governance structures. The EU NFRD, however, requires firms to disclose on ESG issues such as environmental management, social, employee, and community issues, human rights, anti-corruption, and bribery. In addition, the EU Taxonomy Regulation expands how companies can define environmentally sustainable business activities.

Both India and the EU have made significant strides in an attempt to align their ESG disclosure systems with international norms and guidelines. While India's BRSR framework is based largely on the Global Reporting Initiative (GRI) Standards and the Sustainable Development Goals (SDGs) framework, in contrast, the EU's NFRD is based on the GRI Standards and the TCFD guidelines.

Finally, the enforcement and compliance processes vary between the two areas. In India, SEBI oversees listed firms' compliance with the BRSR framework, and noncompliance may result in penalties or regulations. In the EU, national competent authorities in member states monitor and enforce NFRD compliance, and enterprises that fail to comply face penalties or sanctions.

The EU's Corporate Sustainability Reporting Directive (CSRD) expands ESG disclosure obligations, integrating double materiality, which considers both financial risks and a company's impact on society and the environment. India's BRSR framework follows a similar trajectory, mandating disclosures on nine sustainability principles, but SEBI's recent ERP regulations take a step further by introducing transparency norms for ESG rating methodologies.

Strengthening ESG Practices in India

The new ESG regulations introduced by SEBI for large Indian firms are a testament of increasing recognition of the need for a robust ESG policy. However, as India continues to be an evolve as an emerging market, there is a need to adopt a sensible approach where the company focuses not only on enhancing its revenues but is also a responsible player, following stricter ESG rules. In order to enhance the effectiveness of ESG practise in India, several measures could be adopted including: 12

  1. Categorising companies for ESG Evaluation: They could either organise companies into categories by their revenues and the number of employees, and provide an ESG credit based on raw and measurable attributes like carbon emissions, gender and age diversity, job terminations and employee satisfaction among others.
  2. Establishing Independent Regulatory Bodies to prevent Greenwashing: Creating separate regulatory bodies to prevent ESG or greenwashing and having experts in corruption as members of the boards of business companies.
  3. Incentivizing ESG Compliance through Financial Measures: Extending credit for loans based on ESG credit scores and offering tax incentives to firms that abide by ESG compliance can foster sustainability and corporate responsibility.
  4. Lobbying for transparency through local laws akin to the EU's Sustainable Finance Disclosure Regulation (SFDR) and enabling lending to companies that release ESG statements.
  5. Acting as a bridge between firms, investors, civil society organisations, and other stakeholders in terms of sharing knowledge and experience regarding the implementation of ESG projects.

Conclusion: The Future of ESG Regulation in India

With the implementation of SEBI's ERP framework, India is positioning itself as a global leader in sustainable finance governance, ensuring greater transparency, accountability, and standardization in ESG ratings. However, challenges remain, including harmonizing rating methodologies, avoiding regulatory arbitrage, and ensuring compliance enforcement.

As sustainable investments continue to rise, the SEBI-Certified ESG Rating Providers will play a crucial role in shaping India's financial markets. Through effective mitigation of ESG data inconsistencies, enhancing credibility, and aligning these rating with global best practices, SEBI's proactive approach intends to pave the way for a robust and transparent ESG investment ecosystem, ensuring that sustainability is not just a label but a measurable reality.

Footnotes

1 Siddharth Ratra, 'Regulation of ESG Rating Providers in India' (S&R Associates, 20 October 2023) https://www.snrlaw.in/regulation-of-esg-rating-providers-in-india/ accessed 29 January 2025.

2 Vinod Kothari Consultants, 'Regulating ESG Rating Providers in India' (Vinod Kothari Consultants, 24 April 2023) https://vinodkothari.com/2023/04/regulating-esg-rating-providers-in-india/ accessed 29 January 2025.

3 Securities and Exchange Board of India, 'Consultation Paper on ESG Disclosures, Ratings and Investing' (SEBI, 20 February 2023) https://www.sebi.gov.in/reports-and-statistics/reports/feb-2023/consultation-paper-on-esg-disclosures-ratings-and-investing_68193.html accessed 29 January 2025.

4 Securities and Exchange Board of India, 'Master Circular for ESG Rating Providers (ERPs)' (SEBI, 8 May 2024) https://www.sebi.gov.in/legal/master-circulars/may-2024/master-circular-for-esg-rating-providers-erps-_83421.html accessed 29 January 2025.

5 Securities and Exchange Board of India, 'Consultation Paper on Environmental, Social and Governance (ESG) Rating Providers for Securities Markets' (SEBI, 24 January 2022) https://www.sebi.gov.in/reports-and-statistics/reports/jan-2022/consultation-paper-on-environmental-social-and-governance-esg-rating-providers-for-securities-markets_55516.html accessed 29 January 2025.

6 AOTC, 'Client Alert: ESG Regulations in India' (27 December 2023) https://aotcportal.com/wp-content/uploads/2023/12/CLIENT-ALERT-ESG_2712.pdf accessed 29 January 2025.

7 Trilegal, 'Setting the Benchmark: India's First-of-Its-Kind Legislation on ESG Rating Providers' (Mondaq, 10 July 2023) https://www.mondaq.com/india/securities/1357304/setting-the-benchmark-indias-first-of-its-kind-legislation-on-esg-rating-providers accessed 29 January 2025.

8 International Organization of Securities Commissions (IOSCO), Environmental, Social and Governance (ESG) Ratings and Data Products Providers: Final Report (IOSCO, November 2021) https://www.iosco.org/library/pubdocs/pdf/IOSCOPD688.pdf accessed 29 January 2025.

9 Centre for Energy Finance, 'What Is BRSR? A Guide to India's Sustainability Reporting Framework' (CEEW, 2022) https://www.ceew.in/cef/quick-reads/explains/brsr#:~:text=What%20is%20BRSR?,from%20FY%202022%E2%80%9323%20onwards.&text=The%20obligated%20entities%20were%20initially,Affairs%20(MCA)%20in%202019.&text=Each%20principle%20includes%20indicators%20that,under%20the%20nine%20NGBRC%20principles accessed 29 January 2025.

10 James Dunn, 'Regional Comparison of ESG Regulations' (Law.Asia, 24 August 2023) https://law.asia/regional-comparison-of-esg-regulations/ accessed 29 January 2025.

11 European Commission, 'Corporate Sustainability Reporting' (European Commission, 2024) https://finance.ec.europa.eu/capital-markets-union-and-financial-markets/company-reporting-and-auditing/company-reporting/corporate-sustainability-reporting_en accessed 29 January 2025.

12 Deloitte, Business Responsibility and Sustainability Report (BRSR) – India's ESG Disclosure Framework (Deloitte, 2023) https://www2.deloitte.com/in/en/pages/finance/articles/business-responsibility-and-sustainability-report.html accessed 29 January 2025.

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