By Sandeep Parekh
A growing global demand for sustainable business practices amongst investors, regulators and issuers alike, especially fuelled by the pandemic, has shifted the focus to sustainability interventions. A 2021 Bloomberg report anticipated global environmental, social, and governance (ESG) assets to rise to more than $50 trillion by 2025. A 2022 PWC survey found ESG outcomes were a priority for investors in investment decision-making.
Naturally, this increasing demand for integrating ESG factors into a company’s projected growth should be met with consistent and reliable disclosure of ESG information to market participants. Given the subjectivity of information that compri ses ESG, coupled with the difficulty of measuring the impact of such factors, getting access to comprehensible ESG information that could be used to predict a company’s future performance could be challenging. ESG ratings, therefore, seek to address this gap by evaluating the performance of a company rendering an objective score. Third-party service providers such as Sustainalytics, ESGRisk.ai ratings, and MSCI offer such ratings which are relied upon by investors.
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In the past decade, many service providers have entered this industry, albeit without a regulatory oversight or a benchmark for ratings. The International Organisation of Securities Commissions thus recommended securities regulators to increase scrutiny over ESG rating providers (ERPs). Following this, Sebi released a consultation paper proposing accreditation of ERPs and disclosure of ESG rating methodologies and issued a draft framework on February 22, 2023, which was approved by the board. This framework seeks to regulate ERPs under the framework for credit rating agencies.
ESG ratings, however, lack a common definition. While, on the one hand, ESG ratings are thought to measure a company’s impact on the welfare of its stakeholders, on the other, there is a view that these must assess the impact societal and environmental issues have on the former.
The framework approved by Sebi seeks to encompass both stances by defining ESG ratings as “the broad spectrum of ratings products that are marketed as providing an opinion” regarding a listed or proposed to be listed entity, on “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” based on a “defined ranking system of rating categories”. While this offers clarity on the framework’s applicability on many service providers operating in the ESG space, it also allows ERPs to build on comparable methodologies and adopt flexible metrics depending on investors’ goals and expectations.
https://www.financialexpress.com/life/technology-netflix-said-to-report-2-mn-new-subscribers-following-price-cut-ad-supported-plan-launch-3050790/The flexibility to adopt metrics geared towards investor expectations is further supported by the fact that Sebi has permitted ERPs to opt for a subscriber-pays business model, meaning that the detailed rating rationale and report in relation to a particular entity would be available to only those who pay for it. In its consultation paper, Sebi had recommended that ERPs can opt for either issuer-pays or subscriber-pays model. A subscriber-pays model would allow investors greater access to customised analysis in tune with their goals and also mitigate any conflict of interest that is usually found with the issuer pays model. However, its problem lies in getting companies to provide complete and accurate information to ERPs. This could be solved by mandating ERPs to frame a set of “terms of engagement” for efficient procurement of information.
The paper also seeks to classify ERPs under two broad categories for registration with Sebi on the basis of their activities. While Category I would be subject to higher net worth requirements (Rs 5 crore) and stricter promoter eligibility requirements, Category II ERPs must maintain a minimum net worth of Rs 10 lakh and are subject to fewer eligibility and infrastructure requirements. Only Category I ERPs would be permitted to certify green debt securities. Though this column has argued against capital requirements for intelligent work, lower eligibility requirements for Category II ERPs would encourage new entrants specialising in evaluation of these parameters to get registered with Sebi.
Another welcome feature of the new framework is the ‘BRSR Core’ format of disclosure, which comprises select key performance indicators assessing ESG attributes. From FY23 onwards, the top 1000 listed entities by market capitalisation are bound to furnish a Business Responsibility and Sustainability Report , which disclose a listed company’s performance against ESG parameters based on principles in the National Guidelines for Responsible Business Conduct adopted by the ministry of corporate affairs.
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To increase credibility of such BRSR disclosures and minimise green-washing, the BRSR Core format focuses on around 49 parameters, which have been identified as critical areas under each ESG attribute, and listed entities would be required to seek ‘reasonable assurance’ on their performance on such parameters. These KPIs include usage of quantifiable metrics and intensity ratios to allow for global comparability between reports provided by companies as well as disclosure parameters based on India-specific social and environmental challenges.
A separate category of ‘Core ESG Ratings’ shall be provided by ERPs based on the BRSR Core disclosures. This would allow ERPs to create standardised rating products and afford credibility to disclosures made by companies. While top 250 listed entities based on market capitalisation would have to obtain reasonable assurance on the stipulated KPIs from FY24 onwards, Sebi envisages subjecting top 1000 listed entities to the BRSR Core regime by FY 227. The BRSR Core disclosures shall also include disclosures pertaining to supply-chain of a company, which would include use of natural resources, employment practices, emissions, and wastages associated with supply-chain or partner entities. However, considering the complexities involved in measuring and tracking of ESG metrics of partner entities, Sebi has proposed to include BRSR Core for supply-chain of listed entities based on certain thresholds, to be subsequently specified. Further, Sebi aims to introduce a host of measures for ESG schemes, including investment of at least 65% of AUM in listed entities where BRSR Core assurance is obtained and disclosure of voting decisions, etc.
With the above framework, Sebi seems to adopt a balanced approach to address the complexities involved in complying with the extensive BRSR framework as well as eliminate the risks of greenwashing and mis-selling. A substance-based approach may be more beneficial to all stakeholders taking initiatives towards sustainability and social welfare.
Coauthored with Sudarshana Basu, associate, Finsec Law Advisors
The writer is managing partner, Finsec Law Advisors