What is ESG?
ESG is an acronym for Environmental, Social, and Governance. It is a tool that helps stakeholders to understand that how an organization is managing threats and opportunities with respect to environment, social and governance. ESG takes the overall view that sustainability extends beyond just environmental issues.
Environment: Studies organization’s focus on natural environment, energy use, recycling practices, pollution control and conserving resources.
Social: Inspects an organization’s management of relationships with its employees, suppliers, customers, stakeholders and community at large.
Governance: Considers the organization’s management structure, executive compensation, internal controls and Stakeholder rights.
Compliance framework w.r.t. ESG in India
The Regulatory framework in India is not codified under consolidated legislation. There are multiple laws which address ESG related issues. Some of the indicative list of laws are as follows:
Environment: Water (Prevention and Control of Pollution) Act, 1974, Air (Prevention and Control of Pollution) Act, 1981, Environment (Protection) Act, 1986, Wild Life (Protection) Act, 1972, Forest (Conservation) Act, 1980, E-Waste, Battery Waste, Plastic Waste, Solid Waste etc.
Social: Factories Act, 1948, Maternity Benefit Act, Payment of Bonus Act, 1965, Payment of Gratuity Act, 1972, Payment of Wages Act, 1936, Right to Disabilities Act, 2016 etc.
Governance: Securities and Exchange Board of India (SEBI) Act, 1992; Prevention of Corruption Act, 1988, Companies Act, 2013
After enough promotion of above concept there has been dramatic boost in EGS investments, various funds were created for the purpose. The Companies inviting investments on ESG grounds need to be checked by Market Regulator such as SEBI, which is for safeguarding investors interest. SEBI has brought the concept of Business Responsibility and Sustainability Reporting to address the concern in 2021. As a part of annual report top 1000 listed Companies by market capitalization were under mandate to furnish an elaborate report related to ESG.
In Financial Year 2021-22, more than 175 companies reported BRSR on voluntary Basis. With the BRSR becoming mandatory from this financial year (FY 2022-23) and a number of stakeholders such as investors and ESG rating providers placing reliance on disclosures made in the BRSR, assurance becomes key for enhancing credibility of disclosure and investor confidence.1
SEBI on March 29, 2023 concluded its Board Meeting and reflected its plan to introduce BRSR core as the regulatory framework for ESG disclosures by 150 top listed companies. The disclosures will be brought down from 800 parameters to under 50 performance indicators under the Business Responsibility and Sustainability Report (BRSR) Core.2 Proposed BRSR Core format comprising of select essential indicators across all principles that can become the foundation of the assurance process.
The EGS Rating will be based on Core BRSR, to be termed as Core ESG Rating.
Regulatory Framework of ESG Rating Providers in India
With the increasing focus on Environmental, Social and Governance (“ESG”) standards and sustainable development goals, investors across the globe have diverted their attention towards environmentally conscious and socially responsible investments.
An ESG rating is nothing but a performance indicator for measuring companies’ long-term sustainability, growth potential, and future performance in an ever-changing market which in turn allows the investors/lenders to make more informed decisions.
Currently, there is no legal regime governing the ESG ratings and the ERPs providing ESG ratings to Indian entities are not under any regulatory supervision as yet. Therefore, a need was being felt to introduce a regulatory framework that enables the ERPs to respond to new developments in the ESG.
In view of the above objective, the SEBI Board has approved the regulatory framework for ERPs in alignment with the consultation paper brought out by SEBI dated January 24, 2022, on ESG Rating Providers for Securities Markets (“Consultation Paper”)3 to achieve the following:
- enhanced transparency in ESG rating justifications,
- measures to moderate conflict of interest by ERPs,
- facilitating augmentation of transition finance in India, and
- simplifying ESG ratings based on assured data
The Consultation Paper suggest regulation of ESG Rating Providers through SEBI (Credit Rating Agencies) Regulations, 1999. The Rating providers will be required to be registered with SEBI and deliver ratings on Environment, Social and Governance parameters as per the CRA Regulations read with relevant circulars.
Proposed Rating process
- Every ESG rating provider shall have appropriate resources within its group to assign an ESG rating.
- Rating provider shall keep the Board and the general public informed about new ESG rating instruments or symbols introduced by it.
- Ensure that the ESG rating suitably incorporates the environmental, social and governance aspects that are contextual to the Indian market, in a manner specified by the Board from time to time. Provided that nothing contained above shall preclude the provider from offering additional ESG rating products or services.
- ESG rating definition, as well as the structure for a particular ESG rating product, shall not be changed by an ESG rating provider, without prior information to the Board.
- Disclose to the stock exchange(s) where the rated entity is listed, as well as through press release and websites for general investors, the ESG rating assigned to such entity or its securities, after periodic review, including changes in ESG rating/ reviews, if any.
- An ESG rating provider shall have written policies, procedures and internal controls designed to ensure the processes and methodologies are rigorous, systematic, and applied consistently and periodically reviewed and updated.
- An ESG rating provider shall have efficient systems to keep track of material ESG related developments to ensure timely and accurate ESG ratings.
- A provider shall attempt to continually improve information gathering process with entities/securities covered by its products.
- Respond to, and address issues flagged by entities covered by its ESG rating products while maintaining the objectivity of these products.
- Share a draft of the ESG rating report with the rated entity before publication of the same. The provider shall also grant such entity an opportunity of appeal and representation before the provider
- Rating providers will be mandated to furnish to the Board copies of its financial statements, at the close of each accounting period.
With the growing dominance of ESG in regulatory framework, ESG ratings are becoming increasing important for an improved investment decision. Through all the Consultation Papers and reports put forth by SEBI, monitoring of Companies in respect of their ESG responsibility can be anticipated. The thing to look forward for is how everything takes shape in Law and get adopted by market. It’s a heads up for entities to start preparing for additional compliance requirement coming their way. Along with economical goals, environmental and social aims are equally uplifted.