Markets regulator Sebi proposes framework to regulate ESG rating providers

Sebi has proposed that Credit Rating Agencies and research analysts with a minimum net worth of Rs 10 crore would be eligible to be accredited as a ESG Rating Provider

Markets regulator Sebi on Monday proposed a framework to regulate ESG (Environment, Social and Governance) rating providers that seeks to allow credit rating agencies and research analysts to provide such services.

In its consultation paper, Sebi has proposed that Credit Rating Agencies (CRAs)and research analysts with a minimum net worth of Rs 10 crore would be eligible to be accredited as a ESG Rating Provider or ERP.

A listed entity that intends to avail an ESG rating can obtain the same from only an accredited ERP.

Sebi has also proposed that ERPs should specifically mention the domain to which the product is related. For example, carbon risk ratings should not be referred as ESG ratings.

It, further, has proposed that ERPs should offer at least one of the ratings products -- ESG impact ratings, ESG corporate risk ratings or ESG financial risk ratings -- and any other ESG related rating products, which may be appropriately labelled.

In order to avoid any confusion among stakeholders, it has been proposed that ERPs should always use proper terminologies for the products offered by them.

Since the activities of ERPs are typically not subject to regulatory oversight at present, increasing reliance on such unregulated ESG rating providers in securities markets raises concerns about the potential risks it poses to investor protection, the transparency and efficiency of markets, risk pricing, and capital allocation, among others, Sebi said.

Moreover, a lack of transparency in this area gives rise to the risk of green washing and misallocation of assets which could lead to infirmity in such ESG ratings and a consequent lack of trust thereof.

"Therefore, there arises an imperative need, more than ever before, to ensure that the providers of such products operate in a transparent and regulated environment that balances the needs of all stakeholders," Sebi noted.

An ERP should prominently disclose on its website and in the ESG rating reports, the rating scale (symbols and their definitions) used by the ERP.

Additionally, an ERP should ensure consistency in the application of its ESG rating scale.

An ERP should prominently display on its website and in ESG rating reports the type of ESG rating product (whether impact-based or risk-based). It should disclose its rating methodology for all its products on their websites while maintaining a balance with respect to proprietary or confidential aspects of the methodologies.

With regard to the rating process, Sebi has proposed that ERP should follow a proper rating process and ensure consistency in application of its methodology for the same product (as publicly disclosed) across ESG ratings assigned by it.

Every ERP should have professional rating committees, comprising members who are adequately qualified and knowledgeable to assign a rating.

In addition, each ERP should formulate a detailed policy on managing conflict of interest and such a policy should be prominently disclosed on its website.

Sebi has also proposed that ERPs should be mandated to follow a 'subscriber-pay' business model. While investors may be the primary source of revenue in a 'subscriber-pay' model, a subscriber may include an issuer as well.

The Securities and Exchange Board of India (Sebi) has sought comments on the consultation paper from public till March 10.