SEBI’s New Guidelines for ESG Rating Providers

The Securities and Exchange Board of India (SEBI) has introduced new guidelines for Environmental, Social, and Governance (ESG) Rating Providers (ERPs). These measures aim to enhance transparency and accountability in the ESG rating process. The guidelines clarify how ERPs can withdraw ratings and the obligations tied to different revenue models.

Types of Revenue Models

• SEBI outlines two revenue models for ERPs – subscriber-pays and issuer-pays. Under the subscriber-pays model, ERPs can withdraw ratings if there are no active subscribers.
• However, if a rated entity is included in a package like the Nifty 50 index, withdrawal is not permitted.
• For the issuer-pays model, a rating can only be withdrawn after three years or halfway through the security’s tenure, whichever is longer.
• Approval from 75% of bondholders is also required for withdrawal.

Rating Rationale and Disclosure

ERPs using the subscriber-pays model must share detailed rating rationales and reports exclusively with their subscribers. They are prohibited from publishing these reports on their websites. Ratings displayed online must adhere to a specified format. This aims to maintain confidentiality and ensure that only paying subscribers have access to comprehensive rating information.

Stock Exchange Obligations

Stock exchanges are mandated to disclose ESG ratings of listed issuers prominently on their websites. This disclosure must occur under a separate tab or section dedicated to listed companies and securities. For debt securities, the stock exchange where the security is listed must also provide ESG ratings on its website.

Internal Audit and Governance Requirements

SEBI has recognised the challenges faced by category-II ERPs in their early operational years. Therefore, the requirement for these ERPs to conduct internal audits will be implemented after two years from the issuance of the new guidelines. Similarly, the establishment of an ESG Ratings sub-committee and a Nomination and Remuneration Committee (NRC) will also take effect after two years.

Public Consultation Process

SEBI has invited public comments on the draft circular until March 6. This consultation allows stakeholders to provide feedback on the proposed measures. It reflects SEBI’s commitment to engaging with the market and ensuring that the guidelines are practical and effective.

Impact on the ESG Landscape

These new guidelines are expected to impact the ESG rating landscape in India. They aim to enhance the credibility of ESG ratings and encourage trust among investors and stakeholders. By establishing clear rules for rating withdrawal and disclosure, SEBI is promoting a more robust and transparent ESG rating framework.

Future of ESG Ratings

The evolving regulatory environment indicates a growing emphasis on ESG factors in investment decisions. As investors increasingly seek sustainable investment opportunities, the importance of reliable ESG ratings will continue to rise. SEBI’s measures are a step towards ensuring that ESG ratings are trustworthy and informative.

Questions for UPSC:

1. Critically analyse the impact of the new SEBI guidelines on the credibility of ESG ratings in India.
2. Explain the differences between the subscriber-pays and issuer-pays models in the context of ESG ratings.
3. What are the potential challenges faced by category-II ERPs under the new SEBI regulations? Discuss.
4. With suitable examples, comment on the significance of transparency in the ESG rating process for investors.

Answer Hints:

1. Critically analyse the impact of the new SEBI guidelines on the credibility of ESG ratings in India.

1. SEBI’s guidelines enhance transparency by regulating how ratings are withdrawn and disclosed.
2. Mandatory disclosure of ESG ratings on stock exchanges increases accountability for ERPs.
3. Limiting detailed reports to subscribers may raise concerns over accessibility and fairness.
4. Clear rules for rating withdrawal could reduce the risk of arbitrary or biased ratings.
5. Overall, the guidelines aim to build investor trust and improve the reliability of ESG ratings.

2. Explain the differences between the subscriber-pays and issuer-pays models in the context of ESG ratings.

1. In the subscriber-pays model, ERPs are funded by subscribers who pay for access to ratings.
2. Under the issuer-pays model, the rated entities pay for their own ratings, which can create conflicts of interest.
3. Ratings can be withdrawn in the subscriber-pays model if there are no active subscribers, while issuer-pays requires bondholder approval after three years.
4. Subscriber-pays model allows for more confidentiality of reports, whereas issuer-pays may lead to broader public access.
5. Both models have distinct implications for the independence and objectivity of ESG ratings.

3. What are the potential challenges faced by category-II ERPs under the new SEBI regulations? Discuss.

1. Category-II ERPs may struggle with compliance due to limited resources and operational experience.
2. The delayed implementation of internal audit requirements could hinder their governance structures.
3. Establishing an ESG Ratings sub-committee may pose logistical and staffing challenges.
4. Maintaining subscriber engagement and ensuring a steady revenue stream could be difficult.
5. Adapting to the regulatory changes while ensuring credibility and trust among stakeholders is crucial.

4. With suitable examples, comment on the significance of transparency in the ESG rating process for investors.

1. Transparency allows investors to understand the basis of ratings, encouraging informed decision-making.
2. For instance, detailed reports can clarify how companies meet environmental standards, impacting investment choices.
3. Examples like the Volkswagen emissions scandal highlight the need for transparent ratings to avoid misleading investors.
4. Clear disclosure of rating methodologies can help investors assess risks associated with ESG factors.
5. Transparency builds investor confidence, ultimately leading to greater capital flow into sustainable investments.