SEBI proposes a framework to regulate ESG rating providers

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For standardization of ratings and to avoid confusion, SEBI has declared that only an accredited ERP can issue ESG ratings.

On Monday, SEBI has proposed a framework to regulate Environment, Social and Governance (ESG) rating providers. It is on how Credit Rating Agencies (CRA) and research analysts provide such services.

SEBI has proposed in its consultation paper that CRAs and research analysts with a minimum net worth of ₹10 crores can only accredit as an ESG Rating Provider (ERP). A listed entity can only obtain ESG ratings from an accredited ERP.

The regulator also proposed that the ERPs should mention specifically, to which domain the product is related. For example, carbon risk ratings cannot refer to as ESG ratings.

SEBI also proposed that ERPs should offer at least one of these rating products; ESG impact ratings, ESG corporate risk ratings or ESG financial risk ratings and other ESG related rating products that can be appropriately labelled.

To avoid any confusion among stakeholders, they proposed that ERPs should always use proper terminologies for the products they offer.

ERPs are not regulated presently. There is an increasing revulsion towards sin stocks and other unsustainable stocks in the market. Investors prefer the green stocks that are determined by their ESG ratings.

But in this unregulated field, many give faulty ratings. That poses a risk to investor protection, the transparency and efficiency of markets, risk pricing, and capital allocation, among others.

The lack of transparency in this field can also lead to the risk of greenwashing. It could also lead to misallocation of assets, which could lead to infirmity in such ESG ratings and a resulting lack of trust.

Thus, it is necessary to ensure that the providers of such products operate in a transparent and regulated environment, so that all the needs of stakeholders are balanced.

The accredited ERP should disclose on its website the ESG rating reports, and the rating scale (the symbols and their definitions). Also, an accredited ERP should ensure consistency in the application of their ESG rating scale.

The rating reports should declare the type of ESG rating product, whether it is impact-based or risk-based. They should also disclose their rating methodology for all their products on their websites.

They should also maintain a balance concerning proprietary or confidential aspects of their methodologies. While rating, ERP should follow a proper rating process and ensure consistency in application of its rating methodology for its products.

Every ERP should consist of professional rating committees, with members who are adequately qualified and knowledgeable to assign a rating.

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

The regulator has proposed that ERPs should follow a subscriber-pay business model.

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