SEBI’s ESG Rating Reforms: A Step Towards Accountability or Regulatory Overreach?

[Suprava is a student at Gujarat National Law University.]

Environment, social and governance ratings (ESG) are tool for investors who are looking to align their investments with sustainable and responsible business practices. These factors influence capital allocation globally, which is why the integrity and transparency of ESG ratings are being closely examined. In India, the Securities and Exchange Board of India (SEBI) has recently introduced reforms to the framework governing ESG rating providers (ERPs). This blog seeks to examine the updated ESG regulations by the SEBI, analyze their strengths, challenges, and implications for market stakeholders.

Understanding ESG Ratings 

ESG reflects a global push towards sustainable practices into finance decision-making. Nowadays, investors rely heavily on ESG ratings to evaluate companies’ non-financial performance, assess risks, and identify areas of value creation. In capital markets, ERPs play an important role by analyzing corporate disclosure, sustainability reports, and other data to give scores that guide investment decisions.

Despite their importance, these ratings have also been subjected to criticisms, mainly due to the inconsistency and potential greenwashing. This can be explained through Volkswagen's 2009 "clean diesel campaign” where the company marketed its car as environmentally friendly. But, reports highlighted that they installed software to cheat emission tests, and in truth some vehicles were emitting pollutants up to 40 times the legal limit. this deceptive practice by the companies is called Greenwashing, which misleads consumers and investors by exaggerating the company's sustainable efforts. 

Such challenges weaken the trust of the investors and emphasize the need for supervision. Acknowledging this need, SEBI introduced its first ESG rating framework in 2023 which complied with ERPs and the credit rating agencies’ standards. The goal was to set a standard of accountability and transparency in India’s emerging ESG ecosystem. Globally, regulators like the EU and the US Securities and Exchange Commission have also take up steps to regulate the ESG disclosures and rating methodologies, highlighting the critical role of credible ESG ratings in fostering sustainable finance.

Summary of SEBI’s New Regulations

On 29 April 2025, SEBI issued a circular containing reforms for the regulatory system for ERPs in India. These updates build upon the initial ESG rating regulations introduced in 2023.

Withdrawal norms for ERP business models 

One of the key highlights is the introduction of rules for withdrawing ESG ratings based on the ERP’s business model. First is a subscriber pays model, under which operating ERPs can withdraw ESG ratings if there are no active subscribers, or if the rated company fails to file its Business Responsibility and Sustainability Report (BRSR), but if the ratings are a part of a major index such as the Nifty 50, withdrawal is prohibited while subscriptions remain active. In order to maintain data integrity, the ratings are removed from the subscriber access once they are withdrawn.

Whereas under the issuer pays model, ratings can only be withdrawn after a minimum continuous rating period of 3 years or half the tenure of a rated debt security- whichever is higher. Withdrawal of debt security ratings requires a NOC from at least 75% of bondholders by value. This shows that ESG ratings’ withdrawal procedures safeguard investors and are in line with governing credit ratings.

Enhanced disclosure requirements

To strike a balance between operational stability and transparency, the SEBI has updated the disclosure requirements. This has significantly reduced the regulatory constraints as the subscriber-pays ERPs are no longer mandated to publish detailed rationales publicly. But they must disclose assigned ESG ratings in a standardized, year-wise format on their websites, including issuer name, sector, rating date and the BRSR version used. Issuer pays ERPs must continue full public disclosure of rating rationales and maintain transparency consistent with their business models. Further, stock exchanges must display ESG ratings on dedicated sections of listed companies and debt securities pages. This helps the investors make educated decisions which raised the visibility of ESG ratings.

Governance and audit norms 

SEBI requires ERPs to set up independent governance committees and conduct internal audits. Category II ERPs which are usually smaller firms, are granted a two-year extension before the governance and audit requirements take effect. Information system security professionals and cost accountants are not also included in the group of qualified auditors to increase the range of knowledge available. In addition to addressing the operational credibility specific to ERP business model, the update seeks to establish a reliable and investor-friendly grading system by ensuring that the rating process is subjected to scrutiny and independent oversight. 

Strengths and Concerns 

In order to create a stable and healthy financial environment in India, the reforms are essential. But there are advantages to this change as well as significant drawbacks.

The main goal of the reforms is to raise the degree of transparency. A significant change towards this goal is to increase the investor’s access to reliable ESG data which includes year-by-year disclosures of ratings. The new price discovery mechanism also helps in increasing the visibility, needed for the expansion of ESG-linked financial products. The provisions for requiring consent of bondholders and restricting withdrawal for ratings linked to major indices also help in investor protection and market stability. This uniformity helps in increasing the market's trust and reduce any kind of uncertainty,

In spite of these advantages, several issues need to be considered. The provision for condition withdrawal, mainly for subscriber-pays ERPs can lead to short-term fluctuations in how people perceive ESG risks. For example, when ratings are withdrawn due to administrative errors, like missing BRSR filings could cause abrupt changes in investor sentiment and undermine their confidence. The increased compliance burden, especially regarding the governance, audit, and disclosure requirements, may disproportionately affect smaller ERPs, even with the 2-year extension. This could lead to a reduction in rating diversity and possibly hamper innovation. The subscriber-pays model’s viability is also under question. With reduced public disclosure obligations and increased internal systemization costs, ERPs might need to choose issuer-pays or hybrid models which would affect the competition.

The challenge remains whether the regulators can strike the right balance between flexibility and accountability in the nascent stage of the ESG ratings market. Over-regulation risks slow growth, while under-regulation could lead to transparency and credibility issues. SEBI’s reforms try to align with the global best practices but would require further careful implementation and ongoing review to maximize benefits and mitigate risks in India s ESG ecosystem.

Stakeholder Impact Analysis

These reforms have various implications across different participants in the finance landscape. For investors, the reforms promise clarity and reliability in ESG ratings. The standardized disclosures and enhanced transparency on stock exchanges will help in better informed decision making and improved price discovery. But the short-term volatility caused due to the conditional withdrawal mechanism may lead to uncertainty, mainly for those who rely on ratings for risk assessments. Corporations may face increasing pressure during reporting and disclosures, particularly around the time of filing of BRSR. Failure to comply with it may lead to rating withdrawal which can potentially affect the reputation of these companies and their access to ESG-linked capital. This raises the stakes for companies and now they need to invest extra to strengthen the internal ESG data management and governance.

ERPs need to navigate their structure with increasing governance, audit requirements and evolving disclosure provisions. Here, larger firms can adapt smoothly but smaller firms or the Category II firms might struggle with compliance costs in spite of the grace period offered. An effective remedy to offset the disadvantage of smaller firms would be to create a tiered compliance framework where rules are differentiated based on size, capacity or nature of the entity rather than applying a one-size-fit-all model. This can help align disclosure and audit requirements with company's scale and resources. 

Now, even the SEBI has bigger responsibility to monitor compliance, enforce standards and manage market integrity. The regulator must balance fostering innovation with accounting, by having continuous engagement with stakeholders and a periodic framework for reviews. The reforms signal a developing ecosystem but also demand efforts from all the stakeholders to realize their full potential.

Global Context 

The reforms align with global trends where the focus in more on increasing transparency, accountability, and investor protection. Internationally, regulations are driven by frameworks such as G20 Sustainable Finance Roadmap which highlights the high-level principles towards sustainability-linked financial policies and the International Organization of Securities Commissions recommendations, which calls for improved transparency and governance in ESG assessment. 

Further, the establishment of the International Sustainability Standard Board has introduced a global standard for sustainable disclosures and aims at enhancing the reliability of ESG disclosures across nations. When we analyze in the context of different nations, the EU’s ESG ratings regulations mandates full disclosure of rating systems, governance structures, and conflict of interest polices. The framework aims to harmonize ESG ratings across all the member states of EU to reduce the fragmentation. Similarly, US SEC has proposed new rules to improve the ESG disclosure and oversight of rating providers by focusing on quality and to curb greenwashing.

SEBI's move mirrors the global practices signaling that India is ready to foster a credible and transparent ESG ecosystem. However, the unique structure of India’s market and the nascent state of ESG investing show that the regulations need to balance investor protection with actual operational feasibility. Only by combining these global standards with domestic realities can SEBI fully reform the position in India.

Way Forward

Successful implementation of ESG reforms can only take place if there is collaboration among regulators, rating agencies, corporates, and investors. SEBI needs to prioritize capacity-building initiatives, especially for smaller and newer ESG rating providers, to help them meet compliance requirements without any compromise to innovation or market diversity. Periodic reviews are crucial to address the emerging challenges and adapt to evolving global trends. Literacy drives related to ESG among retail investors can help in market participation and informed decision-making. ERPs need to invest in data management systems and transparent communication, especially related to rating withdrawals, to maintain their credibility and investor trust.

The success of these reforms will depend on effective implementation, stakeholder collaboration and periodic refinement. While regulation is crucial, there needs to be a true culture of genuine ESG commitments across corporations and investors for long-term market sustainability.