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  • Deepta Ramakrishnan

Understanding SEBI’s Draft Regulatory Framework for ESG Rating Providers

[Deepta is a student at Tamil Nadu National Law University.]

The world has witnessed a significant surge in the growth of environmental, social, and governance (ESG) investing in the last 5 years, with COVID-19 being cited as the main propeller of this trend. This growth can also be attributed to increasing research and evidence suggesting that businesses focusing on ESG issues have superior management teams and experience improved financial returns. In PwC’s Global Investor Survey, 2022, investors placed ESG factors in their top 5 priorities for businesses to deliver. According to Bloomberg, global ESG assets are set to exceed 50 trillion dollars by 2025, comprising more than a third of the projected total assets under management.

As the influence of ESG investing grows, so does the level of scrutiny it faces, not just from global regulators but also from companies and investors. One area of concern is the limited availability of reliable and consistent ESG data and the lack of regulation for ESG rating providers (ERPs). Yet another issue is the lack of a shared understanding of what an ESG rating measures – whether the company’s impact on the world or the world’s impact on the financial future of the company. For instance, MSCI upgraded McDonald’s Corp.’s ratings, stating that the company had positive environmental practices, despite McDonald’s generating more greenhouse gas emissions than some entire countries. This decision was based on MSCI’s conclusion that climate change does not pose a financial risk to McDonald’s. However, this contradicts the “sustainable investment” connotation that ESG investing is often associated with in popular discourse.

The need to regulate ERPs was felt by the IOSCO, which in its final report on ERPs in 2021, highlighted the need for regulators to focus greater attention on the activities of ESG rating and data products providers within their jurisdiction. Following the release of the IOSCO report, the SEBI published a consultation paper on 24 January 2022, outlining the concerns surrounding the unregulated ESG rating industry and proposed the creation of a more reliable, comparable, and interpretable ESG rating system that adheres to emerging global practices. Consequently, a draft framework was released on 22 February 2023, and approved by SEBI board on 29 March 2023.

The Proposed Regulatory Framework

At the outset, the framework seeks to bring ERPs within the ambit of the SEBI Credit Rating Agencies (CRAs) Regulations 1999, through an amendment to include a chapter for ERPs. Relying on its experience in regulating CRAs, SEBI wants to have an enforceable supervisory framework to govern ERPs, as opposed to a less stringent voluntary code of conduct. More countries are following suit, with the European Commission recently announcing its proposal to control instances of greenwashing by requiring ERPs, including those outside the EU, to obtain certification from the EU’s financial regulator. Some key features of SEBI’s draft framework are discussed below.

Unverified controversies

SEBI’s framework proposes preparing a “core ESG rating” based on Business Responsibility and Sustainability Reporting (BRSR) disclosures made by the company. However, it also allows ERPs to undertake an independent assessment of companies and provide ratings and commentaries based on information and controversies not verified by the company. Industry stakeholders generally concur that unverified controversies should not exert influence on the core ESG rating, and accordingly, the framework does not allow unverified controversies to affect the core rating. It would be beneficial if SEBI also provided certain guidelines on how these commentaries and observations are to be prepared by ERPs and to what degree they can continue on unverified information, despite it being presented as an additional commentary.

Divergence in ratings

One major issue with ESG ratings is that they are rarely consistent across different ERPs. This gives rise to a number of challenges – it defeats the purpose of having an ESG Rating in the first place because investors do not know which rating to consider, it does not incentivize companies to work on improving their rating due to mixed signals from ERPs, and the divergence in ratings also hinders the effective pricing of companies’ ESG performance in the market. Acknowledging these challenges, SEBI has proposed that a detailed report be published along with the rating articulating the rationale behind the rating. While this will not help in resolving the problem of divergent ratings across ERPs, it would enable investors to understand the reasoning behind the ratings they purchase. It is also true that different investors have different priorities and therefore, in a way, diversity in perspectives can also be advantageous.

Business model

The consultation paper proposes two business models. The “issuer pay model guarantees the widespread dissemination of ratings to all investors without imposing any monetary burden on them. Nevertheless, the model engenders inherent conflict of interest issues since the ERP derives its revenue from the issuer. At the heart of the 2007-2008 subprime mortgage crisis lies a nefarious web of complex securities used to finance subprime mortgages, the proliferation of which was enabled, in no small part, by the actions of CRAs. This was a turning point for regulators across the globe in realizing the inherently flawed nature of the issuer pays business model, as it creates an incentive for CRAs to pander to the demands of the issuing company rather than exercising their fiduciary duty to investors.

Thesubscriber pay model, on the other hand, would ensure that the ratings are paid for by those who wish to avail it and thus presents fewer potential conflict of interest issues compared to the issuer-pay model. However, the reports are usually expensive, thus posing a barrier for institutional investors, impeding their access to such information. It has been proposed by SEBI that the permissible business models for ERPs in India include either the issuer-pays or the subscriber-pays model, while hybrid models shall not be permitted, to ensure that investors are not misleaded.


All entities wishing to get accredited as an ERP will fall under two categories. Category I ERPs would be subjected to stringent net worth requirements of INR 5 crores to be maintained at all points of time, with INR 10 crores as the requirement at the time of making the application, further stipulating that the promoter shall maintain a minimum shareholding of 26%. Category II ERPs, on the other hand, are required to maintain a minimum net worth of INR 10 lakhs, with INR 20 lakhs at the time of making the application, along with comparatively lenient eligibility and infrastructure criteria, with an option to have employees work from home as well. This is a welcome step, as the imposition of high capital requirements for a developing service may hinder new entrants, since ERPs can be operated as not-for-profit agencies or be smaller firms that incorporate AI. However, there is apprehension regarding the possible attribution of inferior connotations to agencies falling under the second category.


ESG investing has garnered considerable attention and criticism recently, with figures like Elon Musk calling it the “devil” due to tobacco companies outperforming Tesla in ESG ratings. US Senators are arguing that this investment approach could negatively impact average Americans. At this juncture, it has become necessary to prioritize further research aimed at understanding how ERPs evaluate companies and how ESG investing can positively influence climate change mitigation efforts.

A recent study has demonstrated the feasibility of recalibrating ESG ratings by implementing a standardized taxonomy to guide data analysis. Therefore, while the establishment of a framework governing ERPs is a welcome step from the SEBI, it is recommended that India adopt a green taxonomy framework similar to the EU taxonomy for sustainable activities. This will help in the assessment of whether an economic activity aligns with environmental sustainability objectives. Implementing this will mitigate instances of greenwashing often connected with ESG investments, ultimately redirecting capital flows toward a more sustainable economy.


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