The ESG rating conundrum

News: In recent years, the environmental, social and governance (ESG) investments have emerged as a subject of great interest and significance across the globe. In this context, the SEBI had brought out a consultation paper on the need to regulate ESG rating providers.

Increasingly, corporates are adopting higher ESG norms, and investors are preferring such investments.

Importance of ESG

The ESG investments lead to public good as well as make business sense. They are beneficial for both —the shareholders and all other stakeholders.

Rating by ERPs

The ESG rating providers (ERPs) offer rating products in two categories: (1) risk ratings: an assessment of a company’s resilience to ESG related risks, and (2) “impact” ratings: an assessment of the impact of a company’s operations on the environment and society.

What are the challenges in the development of universally acceptable ESG standards?

Globally, there are no universally recognised ESG reporting standards and frameworks. The investors and corporates have been using different standards and frameworks. For example, GRI, TCFD, SASB, among others. This may lead to greenwashing and misselling, and the potential risks to investor protection, transparency and capital allocation in markets, among others.

There is no consistency in disclosures and transparency of the methodology and rating process.

Assessing impact rating is more complex and arduous compared to risk rating.

Investors are more concerned about risk rating. It means, ESG impact ratings are not the mainstream ESG rating product currently being offered by most providers.

There are concerns over desirability or workability of the universal ESG standard and frameworks. There are different levels of development across different countries in the world. The advanced economies and the emerging economies have made different commitments based on the principle of “Common but Differentiated Responsibilities and Respective Capabilities”. An ESG framework negates the efforts made for equity and climate justice.

ESG investing is still relatively in the nascent stage in India. Many of them do not understand the nuances of ESG investing. They rely on in-house research due to absence of consistent and comparable ESG reporting standards and frameworks.

Way Forward

Global level

A number of international bodies are working on the idea to develop the ESG framework.

For example, The International Financial Reporting Standards (IFRS) Foundation had announced the setting up of the International Sustainability Standards Board (ISSB) at Glasgow Summit in 2021. This is an attempt to develop universally acceptable reporting standards and frameworks.

India

India has already developed and put in place our own business responsibility and sustainability reporting standards (BRSR). This takes into account the viewpoint of stakeholders, domestic considerations and international best practices.

For example, the BRSR reporting framework is inter-operable with international frameworks like GRI, TCFD and SASB.

Sebi regulations mandates top 1,000 listed companies to compulsory report in accordance with the BRSR standards from the year 2022-23 onwards. Other listed or even unlisted companies could voluntarily adopt these standards.

The domestic ESG rating providers industry is still at a stage of infancy in India. The demand is mostly met by the foreign ESG rating providers which are unregulated and following varying standards at present. Therefore, there is an urgent need that India put in place a regulatory framework to accredit ERPs.

Source: The post is based on an article “The ESG rating conundrum” published in the Business Standard on 23rd May 2022.

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