Strengthening SEBI’s ESG Rating Regime

[Gaurav and Vedant are students at Hidayatullah National Law University.]

With substantial interest and growing importance of the environment, social and governance (ESG) criteria, there is a growing need among investors for an objective way to assess a company’s ESG performance. Thus, the Securities and Exchange Board of India (SEBI) vide its master circular on ESG rating providers (ERPs) dated 11 July 2025 (Circular) has introduced a comprehensive set of obligations and requirements on ERPs which will aid in the development of the growing trend of sustainable investing. The Circular is in furtherance of SEBI’s existing objectives of eliminating ambiguity surrounding ESG ratings and the diverse range of products offered by ERPs, while ensuring consistency, transparency, and clear disclosures in the methodology and rating process.

While SEBI’s detailed effort to improve transparency and consistency in the ESG rating system is a positive step, the Circular still has certain shortcomings. Main concerns inter alia include the wide definition of ‘ESG rating’ under the SEBI (Credit Rating Agencies) Regulations 1999 (CRA Regulations) and no clear guidance on what methodology ERPs should follow.

The article examines the aforementioned challenges, especially the confusion around the methodologies used by ERPs. Additionally, the authors explore the potential of such gaps to slow down the growth of India’s nascent ESG framework. While doing so, the authors aim to provide certain practical solutions addressing the identified issues to strengthen the ESG rating framework, thereby making it more reliable.

ESG Rating Differences: Scope, Measurement and Weightage

ESG ratings often vary across different ERPs due to 3 main factors. The first is the scope, which refers to the specific attributes the rating provider chooses to measure. The second is the measurement, which relates to the methods used to assess and evaluate these attributes. The third is the weightage, which indicates the level of importance assigned to each attribute compared to the others.

Scope 

Internationally, there is a lack of a uniform definition of ‘ESG rating’. SEBI, through the CRA Regulations, has attempted to provide a holistic solution to the aforementioned lack of clarity. As per the CRA Regulations, ‘ESG rating’ is defined as “the rating products that are marketed as opinions about an issuer or a security, regarding its ESG profile or characteristics or exposure to ESG risk, governance risk, social risk, climatic or environmental risks, or impact on society, climate and the environment, that are issued using a defined ranking system of rating categories, whether or not these are explicitly labelled as ‘ESG ratings’.”

The authors submit that the definition unreasonably expands the scope of ‘ESG rating’, thereby causing unnecessary confusion. There is uncertainty as to whether ERPs are rating the ESG ‘risk’ of a company or security in an ex-ante way or if they are checking the ESG ‘impact’ of the company or security on society and environment in an ex-post manner.  

Risk ratings check how strong a company is against ESG related risks and how these factors may change its enterprise value. This view is rather investor-centric, focusing on how ESG issues matter for financial results. Alternatively, an impact rating looks outward at how the company actually affects the environment and society. This includes data like greenhouse gas emissions, sustainability work, and corporate social responsibility actions.

Without a clear regulatory guidance on about what exactly an ESG rating should mean, the methodologies ERPs use become unclear. This affects the accuracy, consistency, and interpretability of the end results of the ERPs. 

Measurement

The issues with respect to measurement are twofold. First, the Circular provides the attributes that are required to be considered by the ERPs in each individual aspect of ESG but fails to provide any considerable guidance on how to measure the same. Second, the Circular mandates that the ratings must be sector agnostic.

The Circular mandates a standardized 0–100 scale for ESG ratings but fails to prescribe uniform methodology for ERPs to calculate it. This means ratings from different ERPs might look the same on paper but are calculated using different methodologies. While such freedom may help the ERPs to innovate methodologies, there is a risk of 2 ERPs rating the same company differently. This deviation gets worse because Annexure 5 of the Circular exempts the ERPs from disclosing models, algorithms, or benchmark datasets.

This contributes to the ‘black box’ problem i.e., the difficulty in understanding how ERPs arrive at their decisions resulting in a lack of transparency. To contribute further to the ‘black box’ problem the Circular offers little sector-specific guidance on how ERPs should identify and weight material ESG factors. ERPs can choose their own weights for the E, S, and G components without any regulatory guidance on adjusting the same for different industries. For example, environmental issues matter more for energy companies and social issues may matter more for service companies. Without sector-specific regulations ratings may be inaccurate. 

Methodologies are often complicated. For instance, CareEdge ESG Ratings uses 24 themes and about 400 key indicators, Crisil ESG Ratings uses more than 500 key performance indicators for evaluation, and ESGRisk.ai uses 16 themes, 34 key issues and 1,108 data points. Without some common standard, these diverse methodologies make ratings harder to interpret and compare, showing the black box nature of ESG ratings.

Additionally, Clause 5 of the Circular mandates sector-agnostic ESG ratings thereby increasing the risk of inaccuracy. For example, high-impact industries like construction or manufacturing may get low scores even if they are improving in terms of ESG progress, while low-impact sectors like technology may get higher scores without much effort. This undermines the comparability and fairness of ratings, distorting market perception and investment decisions.

Weightage

The Circular has failed to provide a standard weight to the individual aspects of ESG. The industry variance in weightage can be seen below.

Sr. No.	ERPs	Environment	Social	Governance
1.	CareEdge ESG Ratings	38%	36.5%	25.5%
2.	Crisil ESG Ratings & Analytics limited	35%	25%	40%
3.	ESG Risk Assessments & Insights Limited	29%	37%	33%

Variance in ESG factor weightages allows issuers to select ERPs whose methodologies favorably align with their strengths, enabling ‘rating shopping.’ A company engaged in an environmentally harmful business may choose an ERP that places relatively less value on the environmental aspects of the rating. Additionally, in an issuer-pays model, this undermines objectivity, as companies may gravitate toward raters offering higher scores, compromising consistency, credibility, and investor trust in the ESG rating landscape.

ESG Rating Divergence: Market Implications and Emerging Legal Challenges

The big difference in ESG ratings from different ERPs is having wide impact on market. At the main level, this inconsistency is hindering the main purpose of ESG ratings which is to give a fair trusted assessment of how a company is doing in environmental social and governance standards. When ratings vary, investors and other stakeholders get confused. They find it hard to judge companies, funds or, portfolios. Many times this can even lead to wrong decisions. Additionally, such divergence is making less reason for companies to improve ESG work. 

When different rating agencies give mixed signals, companies are unsure as to what actions will be appreciated or rewarded so they avoid putting money and effort in sustainability projects. Additionally, for researchers and regulators, the lack of consensus creates complications. Studies show one result with one provider and opposite with another. This makes good policy making and analysis difficult.

Apart from these points, the differences in methodology used by ERPs may lead to commercial losses in relation to reputation and legal disputes. For example, in Isra Vision v. Institutional Shareholder Services (ISS), the Regional Court of Munich gave a preliminary injunction, stopping ISS from publishing the worst (D-) ESG rating for Isra Vision. The rating was only based on publicly available data because the company did not respond to ISS request for sustainability review. The court stated that such rating was unjust. It criticised ISS methodology for not matching with Isra Vision’s business operations. This became first known case in Germany where a company won against an ESG rating. 

For India, where standard ESG methodologies are still developing, the above-discussed case raises questions on the need for greater transparency in methodologies and industry co-operation.

Strengthening ESG Ratings: Adopting Dual and Sector-Specific Frameworks

The authors submit that SEBI may follow the EU’s dual ESG rating system by making ESG rating providers give two separate scores. One will check risk materiality to see changes in the company’s enterprise value and the other will check impact materiality on the environment and society from the company’s activities. This dual rating model makes the scope and purpose of each rating clearer. It helps investors to see difference between risk-based and impact-based analysis. It also brings more transparency, reduces confusion, stops rating shopping and matches India’s framework with global best practices like EU’s CSRD and ESG ratings regulations.

Along with this, SEBI should use sector-specific ESG ratings so that companies facing same type of environmental, social and governance issues can be compared in a fair manner. ESG risks and materiality are not same for all industries. For example, emissions are a big issue in energy sector but in technology companies data privacy is more important. Sector-specific ratings make comparison better because they judge companies against others in same industry. It also pushes companies to improve in their own operational area instead of generic benchmarks.

This kind of approach also helps investors to take better decisions as they understand how a company is handling sector relevant ESG matters. It reduces unfair punishment for companies in high impact sectors like manufacturing or construction by focusing on relative performance and not absolute score. In the end, sector-specific ESG ratings make evaluations fairer, more transparent and useful. It fits better with what investors need and what regulators expect.

Conclusion

SEBI’s circular is a good step towards regulating ERPs. However, there is still not enough clarity on what exactly the ratings are trying to achieve. Methodologies are inconsistent and the lack of sector specific requirement raise big challenges. These problems can reduce investor trust and make India’s growing ESG system look less reliable. To make the framework stronger, SEBI should think about using a dual rating system which separates risk materiality and impact materiality. Additionally, sector-specific models should be used so ratings reflect the real ESG concerns of each industry. These changes will make things more transparent and improve comparison between companies. In the long run it will help in building a more reliable and globally aligned ESG rating system.