News & Analysis

ESG Ratings and SEBI’s Outlook

SEBI appears to be tightening the ESG rating process asking agencies to revisit their views in case of future controversies

The Hindenburg allegations appear to have had a fallout on the way ESG rating providers in India have functioned in the past. Market regulator SEBI had come out with a consultation paper around the framework for rating agencies in February and is suggesting that rating providers should revisit their earlier numbers in case of any new controversies. 

In fact, some of the global ESG rating providers had taken cognizance of the report by Hindenburg Research around the Adani Group issues and made changes to their assessment parameters. It looks like SEBI isn’t too happy that Indian agencies didn’t do the same and the market regulator now wants them to follow suit. 

What does SEBI’s note say?

SEBI had released a consultation paper around the regulatory framework for ESG reporting back on February 20, barely a month after the New York-based short-seller Hindenburg had come out with the allegations against the Adani Group. 

“In  order  to  enhance  transparency  in  ESG  ratings  and mitigate  conflict  of interests in ESG rating providers (ERPs), SEBI has issued a Consultation Paper seeking  feedback  on  the  need  for  a  regulatory  framework  for  ERPs  in  the securities market. Pursuant to feedback received during public consultation, a regulatory framework for ERPs is under development,” the market regulator had said in this paper. 

SEBI has proposed that all core ESG ratings should be based on assured or verified data based on the business responsibility and sustainable reporting (BRSR) principles. To this, it has added that in case of unverified controversy on a rated company, the agency must provide additional opinions or observations and factor its impact, if any. 

Once rated, the onus is on the agency

What the market regulator appears to be saying here is that while ESG rating agencies should follow the basic rules while evaluating company disclosures, this alone may not suffice in the future as enterprises need to be aware of any adverse impact that controversies involving their ESG scores could bring at any time in the future. 

In other words, the rating agencies would have to continuously assess not just the qualitative metrics around ESG, but also the quantitative aspects of the same, especially with regard to how the business is working towards further strengthening its governance practices around the matters relating to sustainability. 

Who provides guidelines for further rating?

Of course, critics believe that the SEBI document does not provide guidelines on how these rating agencies should go about getting specific responses in case of unverified controversies. In case, this aspect is missing, the agencies would be free to comment without actually judging the potential outcome of such controversies. 

Should such unverified controversies result in a reduction in the ESG ratings? This question becomes critical as the rating agencies need to have internal policies around what they would consider as information that was not provided and how much of it can be sought before the agency decides on whether the ratings need to change. 

In spite of these questions around the ESG rating system, the fact remains that Indian providers would be forced to take up additional work in terms of assessments and re-evaluations of their assessment filters as well as the quality of data that they gather. Globally, this appears to be the norm, as was evident from Morgan Stanley Capital International ESG Research changing ESG parameters of the Adani Group post the Hindenburg report. 

In a statement the research agency had downgraded their earlier assessment following the controversy to ‘moderate’ from ‘minor’ having identified issues relating to governance, independence of the Board and some transactions. Of course, this shift did not change the overall ESG ratings of the Adani group companies. 

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