SEBI Consultation paper on ESG disclosures, ratings and investing

1. Objective

This Consultation Paper seeks public comments on the regulatory framework of ESG Disclosures by listed entities, ESG Ratings in the securities market and ESG Investing by Mutual Funds in order to facilitate balance between transparency, simplification and ease of doing business in an evolving domain.

2. Background

2.1 In recent years, there has been a growing recognition of the significant economic and financial impact of climate change and environmental, social and governance (ESG) risks. In the past 3 years, a number of ESG funds have been launched, including in India. As ESG Investing becomes mainstream, companies have been urged by both investors and regulators to make detailed ESG related disclosures to their stakeholders. The use of ESG ratings and rating products is also growing, as investors increasingly factor ESG parameters in their investment decisions. In this backdrop, securities market regulators have felt a need to streamline these three areas of ESG Disclosures, ESG Ratings and ESG Investing.

2.2 In India, SEBI has mandated the top 1000 listed companies (by market capitalization) to make ESG disclosures as per the Business Responsibility and Sustainability Reporting (BRSR) from FY 2021-22 on a voluntary basis and mandatory from FY 2022 – 23. SEBI is working on developing a regulatory framework for ESG Rating Providers (ERPs), pursuant to public consultation in this regard. SEBI, through AMFI, has also mandated disclosures for ESG labelled Mutual Funds.

2.3 However, opportunities for streamlining remain in each of the aforementioned areas. In the area of ESG disclosures, the need for assurance and expanding the scope of disclosures beyond the stand-alone listed entity, are key requirements. Further, given that different jurisdictions have different NDCs (Nationally Determined Contributions) & have adopted varied transition paths and have diverse operational realities, sustainability related risks, opportunities and impact may vary across geographies. There is therefore a need for ESG Rating providers to factor in the local / domestic context while assigning ESG ratings. In the area of ESG Investing, there is a need to ensure robustness of disclosures and undertake measures to mitigate the potential risk of green-washing and mis-selling.

2.4  To address the above concerns, SEBI, in May 2022, constituted the ESG Advisory Committee (“EAC / Committee”) to make recommendations to streamline the regulatory framework for ESG Disclosures, ESG Ratings and ESG Investing (Reference – Press release dated May 06, 2022¹). The Committee had representatives from corporates, investors, rating providers, Mutual Funds, industry bodies, academicians, technical experts and other stakeholders and was chaired by Shri. Navneet Munot, MD and CEO, HDFC AMC.

2.5 The Committee gave its recommendations in the areas of ESG Disclosures, ESG Ratings and ESG Investing. This Consultation Paper is based on the recommendations of the EAC and internal deliberations. The same is divided into three parts – Part A, Part B and Part C on ESG Disclosures, ESG Ratings and ESG Investing, respectively.

3. PART A – ESG Disclosures

3.1  Need for review

3.1.1 SEBI has mandated the top 1000 listed companies (by market capitalization) to make filings as per the Business Responsibility and Sustainability Reporting (BRSR) from FY 2022 – 23. In FY 2021 – 22, more than 175 companies reported on the BRSR framework, on a voluntary basis.

3.1.2 With the BRSR becoming mandatory from this financial year (FY 2022-23) and a number of stakeholders such as investors and ESG rating providers placing reliance on disclosures made in the BRSR, assurance becomes key for enhancing credibility of disclosure and investor confidence. Another area where more visibility and transparency is required is ESG disclosures by supply chain participants of Companies. EAC focused its discussions on the said issues and identified few critical areas for mandatory assurance.

3.1.3 In addition to the above, EAC also deliberated on other areas such as enhancing of BRSR by shifting few leadership indicators to essential, sector specific disclosures to bring in greater standardization in reporting, reporting boundaries including segment wise disclosures for conglomerates operating in multiple segments & disclosures on a consolidated basis, along-with assurance of the entire BRSR. However, considering that the reporting on BRSR is still at a nascent stage, aforementioned areas in the reporting format are recommended to be taken up at a later stage once the existing disclosures have stabilized.

3.1.4 Considering the above, this Consultation Paper seeks public comments on the areas of assurance of certain key ESG Disclosures by corporates along with reporting and assurance of ESG footprint of the supply chain of companies.

3.2  Proposals for Public Consultation

3.2.1 Assurance of sustainability disclosures

a. Assurance of sustainability reports, is key to bringing credibility and maintaining investor confidence.

b. Assurance can be either limited or reasonable. Limited Assurance is being adopted globally by jurisdictions as it is relatively easy to implement. However, due to its inherent nature, limited assurance draws relatively low confidence, while reasonable assurance despite being relatively more expensive, draws more confidence.

c. In order to achieve the twin objectives of improving credibility and limiting the cost of compliance, BRSR Core (Annexure 1) has been developed for reasonable assurance which consists of select Key Performance Indicators (KPIs) under each E, S and G attributes / areas that needs to be reasonably assured. The BRSR Core framework also specifies the methodology to facilitate reporting by corporates and verification of the reported data by an assurance provider.

d. The following approach was adopted by the EAC in developing the BRSR Core² –

i. Quantifiable and outcome oriented metrics

The KPIs sought in the BRSR Core are quantifiable to the extent possible, so as to facilitate comparability of the disclosures. The KPIs also incorporate metrics that are reflective of sustainable outcomes in companies. To illustrate, one of the metrics recommended by the Committee is ‘gross wages by gender’ which is reflective of whether a Company has gender diversity practices which attract and retain women in its workforce.

ii. Relevance of the attributes / areas in the BRSR Core

The BRSR Core contains factors that are relevant to both the manufacturing and service sectors and are relevant in the Indian Context. Thus, under the ‘S’ parameters, attributes such as job creation, and inclusive development are considered. The ‘G’ parameters include open­ness/ concentration of business including related party transactions.

iii. Comparability across jurisdictions

The KPIs in the BRSR Core, contain a number of intensity ratios, such as intensity of Green-House Gas (GHG) emissions, water consumption, waste generation etc., so as to enable comparability, irrespective of the size of the Company. These intensity ratios are based on both revenue and volume. Considering that these ratios are also used by global investors and global ERPs, it is felt appropriate that intensity ratios based on economic value adjusted for Purchasing Power Parity (PPP) should be computed in addition to the normal intensity ratios, for global comparability to be fairer to low cost / developing economies. In the first phase, country level PPP may be used and over time, sector specific PPP may be developed.

e. The comprehensive BRSR shall be updated to incorporate KPIs proposed in BRSR Core that are currently not present in the comprehensive BRSR.

f. In keeping with a glide path approach, reasonable assurance of KPIs in BRSR Core may be mandated in a gradual manner, as under:

g. For Public Comments – Issue 1

Comments are sought on the following issues:

i. Whether the attributes and KPIs specified in the BRSR Core are appropriate.

ii. Whether assurance should be obtained only on the attributes and KPIs proposed in the BRSR Core, or on the comprehensive BRSR.

iii. Whether the methodology proposed for assurance is appropriate.

iv. Whether intensity ratios based on economic value adjusted for PPP, should be computed in addition to normal intensity ratios, for global comparability.

v. Whether the timelines proposed at point 3.2.1 (f) above, are appropriate for implementation.

3.2.2 ESG disclosures for supply chain

a. At present, the metrics related to the supply chain of a Company are covered under leadership indicators in the BRSR, that may be reported on a voluntary basis. However, for a number of companies, significant ESG footprints such as the use of natural resources, employment practices, emissions and wastages may be found in their supply chain. Thus, investors are increasingly seeking ESG disclosures for the supply chain, so as to get a complete picture of the ESG risks and impact associated with the products and services provided by the Company.

b. At the same time, it is recognized that there are a number of complexities associated with ESG disclosures for supply chain. Considering that a number of supply chain partners may be small, unlisted firms, it may be difficult for such companies to track and report on a large number of ESG metrics. Further, for certain companies, especially in the manufacturing sector, there may be multiple tiers of suppliers within their supply chains.

c. In view of the above, it is thus proposed to introduce a limited set of ESG disclosures i.e. BRSR Core in a gradual manner and on a “comply-or-explain” basis. The proposed implementation plan, is illustrated below:

d. For Public Comments – Issue 2

Comments are sought on the following issues:

i. Whether there is a need to introduce ESG disclosures for supply chain of listed entities.

ii. If so, should such disclosures be made as per the BRSR Core or comprehensive BRSR.

iii. Whether assurance of disclosures of supply chain should be specified.

iv. Whether timeline as proposed at point 3.2.2 (c) above, for implementation of ESG disclosures and assurance for supply chain is appropriate.

PART B – ESG Ratings

4.1 Need for review

4.1 In order to enhance transparency in ESG ratings and mitigate conflict of interests in ESG rating providers (ERPs), SEBI had issued a Consultation Paper seeking feedback on the need for a regulatory framework for ERPs in the securities market. Pursuant to feedback received during public consultation, a regulatory framework for ERPs is under development.

4.2 Another area that needs deliberation in this space is whether ERPs factor in the domestic context while assigning ESG ratings. This need is felt since ESG in emerging markets, is different as compared to developed jurisdictions. Emerging markets have a different set of environmental & social challenges and it is critical for ERPs to consider these while assessing company’s ESG risks / opportunities and impact. Thus, there is a need for a unique set of metrics that should be factored in, while assigning ESG ratings. For instance, in the Indian context, issues such as job creation in smaller towns, gender diversity at an employee level, and inclusive development are much more relevant than in the developed markets.

4.3 In view of the above, the ESG Advisory Committee identified ESG parameters that are relevant to Indian context that may be integrated in at least one of the ESG ratings for an Indian company. This Consultation Paper seeks public comments on the same.

4.2 Proposal for Public Consultation

4.2.1 ESG ratings with Indian context

a. During its deliberations on identifying ESG parameters that are critical as well as those that are unique to the Indian context, the Committee was cognizant that it was not attempting to standardize or prescribe a uniform methodology for ESG ratings. The efforts of the Committee were geared towards identifying a minimum set of parameters to bring in consistency and aid ERPs in adopting a broad common approach, so as to make ESG ratings comprehensive as well as contextual. While identifying these parameters, the Committee endeavored to ensure that they are reflective of environmental, social and governance outcomes.

b. Based on the recommendations of the committee and internal deliberation, a list of 15 ESG parameters that have an Indian context is appended at Annexure 2. It may be noted that there would be no restriction on the ERPs to evolve additional customized ratings for specific user groups, depending on user needs.

c. A brief on the approach adopted while identifying the aforementioned list, is placed below:

i. Environmental Parameters

India has its own standards, disclosure mandates and norms set by various bodies, such as the Perform Achieve and Trade (PAT) scheme, Extended Producer Responsibility (EPR) scheme etc. It is natural for Indian companies to align their processes as specified by Indian standards. Therefore, it is imperative for ERPs to assess companies based on these standards as mapped against global standards. Any areas of differences can be used to suitably adjust / annotate the ratings.

ii. Social Parameters

Social realities of India are different and unique from developed nations. For instance, workforce diversity assessment is an important social factors assessed by ERPs, however the metrics of such assessment would vary across jurisdictions. In developed countries, presence of women directors on boards may be reflective of workforce diversity whereas in India, an enabling environment and more comprehensive gender diversity in the entire workplace is even more relevant, which gets reflected, for instance, in the percentage of gross wages paid to women by the companies.

iii. Parameters on Governance

A common feature of listed companies in India is the presence of promoters or controlling shareholders. A significant aspect of governance, arising from such ownership is the potential for conflict of interest between the controlling and minority shareholders. One area where this conflict may typically arise, is Related Party Transactions (RPTs). Further, while SEBI has placed significant responsibility on Independent Directors (IDs) for RPT approvals, there have been concerns on whether IDs are truly independent.

In view of the above, the parameters identified cover areas related to RPTs and Independent Directors such as percentage of against votes by non-promoter shareholders on RPTs and IDs, royalty payments etc. Further, given that RegTech systems can aid companies in automating and improving compliance, another parameter identified is whether a Company has RegTech /Systems solution for monitoring and evidencing compliance.

d. For Public Comments – Issue 3

Comments are sought on the following issues:

i. Whether the identified parameters are appropriate for ERPs to factor in ESG aspects that are contextual to the Indian domestic markets, in their ESG ratings.

ii. Whether the proposed guidance on environmental measures is appropriate?

4.2.2 ESG Ratings on assured indicators

a. It is observed that currently, ESG Ratings are generally assigned based on self-reported data by corporates, without any third-party assurance of such data. Since investors are placing increased reliance on these ratings for making investment decisions, it is imperative that these ratings are reliable.

b. In this context, since the proposed BRSR Core provides for disclosure of assured KPIs, it is proposed that in addition to their other products, ERPs shall also provide a Core ESG rating, which shall be based on information / reports that are assured / audited / verified.

c. For Public Comments – Issue 4

Comments are sought on the following issues:

i. Whether there is a need for a Core ESG Rating, based on limited ESG indicators that are assured / audited

ii. Whether having Core ESG Ratings would increase the reliability of ESG ratings

5. PART C – ESG Investing

5.1 Need for review

5.1.1 In the area of ESG investing, AMFI in consultation with SEBI has inter-alia prescribed the following norms for ESG schemes of Mutual Funds:

a. Disclosures in Scheme Information Document (SID) such as scheme name to reflect nature and extent of the scheme’s ESG focus, Investment Objective to provide transparency about the nature and extent of the scheme’s ESG related investment objectives, Investment Strategy – Exclusions, Integration, Best-in-Class & Positive Screening, Impact investing, Sustainable Objectives etc.

b. Disclosures related to engagement undertaken by AMCs for ESG schemes (Monitoring and Evaluation, stewardship and shareholder engagement disclosures, periodic portfolio disclosures and maintenance of ESG policy related to investments)

c. General obligations related to declaration, resource augmentation, marketing material and development of common sustainable finance-related terms and definitions in line with global standards etc.

5.1.2 Additionally, in order to standardize the ESG scoring process, SEBI has advised AMFI to empanel ERPs based on the parameters proposed by a Working Group set up by SEBI, under each of the three pillars viz. Environment, Social and Governance. ESG schemes are required to use scores arrived at by AMFI empaneled ERPs and publish securities wise and scheme wise scores in the monthly portfolio disclosures w.e.f August 01, 2022.

5.1.3 Since the concept of ESG investments and standardized disclosures for funds in the ESG space is still emerging, there is a need for consistent, comparable, and decision-useful scheme disclosures to enable investors to make informed investment decision and to prevent greenwashing. Accordingly, the ESG Advisory Committee provided recommendations on expanding the disclosure norms for ESG funds and on measures that may be brought in to improve transparency, with a particular focus on mitigation of risks of mis-selling and greenwashing and other related areas.

5.1.4 Based on the recommendations of the ESG Advisory Committee and further analysis, comments on proposals relating to ESG schemes of Mutual Funds are being sought.

5.2 Proposals for Public Consultation

5.2.1  Enhanced Stewardship Reporting for ESG schemes

a. Voting disclosures by ESG schemes

i. The importance of institutional investors in capital markets across the world is increasing and they are expected to shoulder greater responsibility towards their clients / beneficiaries by enhancing monitoring  and engagement with their investee companies. Towards this, increased engagement by AMCs/Mutual Funds is imperative for improved corporate governance in the investee companies as well as for protection of the interest of the unitholders.

ii. Mutual Funds under the current regulatory framework are required to mandatorily follow a Stewardship Code in relation to their investments in listed companies which inter-alia includes having a clear policy on voting, compulsory voting in respect of the resolutions including Social and Corporate responsibility issues, related party transactions of the investee company etc., and public disclosure of voting decisions along-with rationale for decision.

iii. In order to have more transparency on the votes cast by ESG funds on resolutions of their investee companies, it is proposed that AMCs need to provide better clarity on ‘in favour” or “against” votes cast on resolutions in a year by disclosing if the resolution has or has not been supported due to any environmental, social or governance reason.

iv. Further, as the Mutual Funds may have holdings in the same investee company(ies) under non-ESG funds also, in cases where the voting approach for ESG and non-ESG schemes is same, the reporting may be made on a fund house level on “in favour” or ‘against” votes. However, in instances where the voting approach for ESG and non-ESG schemes is not similar, AMCs should provide details and rationale for “in favour” or “against” votes cast on resolutions for ESG schemes and non-ESG schemes separately.

v. Voting disclosures to be mandated from FY 23-24 i.e, for annual general meetings held from April 01, 2023 onwards.

vi. For Public Comments – Issue 5

1. Comments on the proposal at para 5.2.1(a)

2. Whether enhanced voting disclosures should be from April 01, 2023 onwards?

b. Disclosure of case studies

For further enhancement of stewardship reporting requirement, the following is proposed:

i. ESG schemes can start with details of case studies where the fund manager/analysts have engaged with portfolio companies with a clear objective of engagement. In case the engagement is on topics requiring multi-year engagement, the strategy for the same should be reported.

ii. The engagements carried out for exercise of votes may also be reported here.

iii. Further, when the case studies mature, ESG schemes would be expected to report how many engagements were carried out in a year, the modes of communication employed, and if any outcomes were achieved in the reporting year. This could be done based on number of companies covered and percentage of AUM covered.

iv. In this regard, if ESG schemes have a specific objective, then reporting should be done on engagements and outcomes achieved (if any) based on that objective in the reporting year. Funds that feed in ESG funds, and any new funds that fall under the umbrella of ESG, like low carbon funds/gender diversity funds/impact funds etc. would also have the same requirement of enhanced stewardship reporting.

v. A glide path is proposed in this regard wherein the disclosure of case studies may be carried out after one year (i.e, from FY 2024-25 onwards) and coverage of engagement number of company wise and AUM-wise, after one more year (i.e, from FY 25-26 onwards).

vi. For Public Comments– Issue 6

1. Whether any other area needs to be covered under disclosure of case studies?

2. Is the glide path suggested appropriate?

5.2.2  Mitigation of risks of mis-selling and greenwashing

The possibility of risk of greenwashing can exist at both investee company level as well as the scheme level and thus needs to be mitigated at both levels. With regard to greenwashing at investee company level, SEBI in this consultation paper has proposed mandatory assurance of disclosure in BRSR Core for top 250 companies from FY 2023-24. Further, ERPs are proposed to be mandated to provide BRSR Core rating based on information/report that are assured/verified/audited.

Having regard to the above, the following is proposed for mitigation of green washing at scheme level.

a. An ESG scheme shall invest at least 65% of its AUM in companies which are reporting on comprehensive BRSR and are also providing assurance on BRSR Core disclosures. The remaining investments of the scheme shall be in companies reporting on BRSR.

b. Considering that BRSR Core is proposed to be effective from FY 2023-24, the aforementioned investment norms is proposed to be made effective from October 01, 2024 onwards. The schemes which are not compliant with abovementioned criteria as on October 01, 2024 may be provided a time period of one year i.e. till September 30, 2025 for compliance. During the said period of one year, no fresh investments in companies without BRSR Core disclosures should be taken up till the required criteria is met.

c. Under the monthly portfolio disclosure, security wise BRSR Core rating/scores shall also be disclosed as and when the same is made available by ERP.

d. It is further proposed that a third party reasonable assurance regarding the scheme portfolio being in compliance with stated strategy and objective of the scheme, may be introduced on a “comply or explain basis” from April 01, 2023 and may be made mandatory from April 01, 2024.

e. It is also proposed that certificate from Mutual Fund may also be mandated from April 01, 2023 (i.e, for FY 2022-23) based on an internal ESG audit which may include checking the SID, Stewardship Reporting and Responsible Investment Policy of the ESG Fund etc., to ensure what is being claimed in these documents is true and factual. In this regard, it needs to be discussed whether a Trustee or AMC certificate should be mandated.

f. As regards making Trustees responsible for a certificate, reference is drawn to a Consultation paper floated by SEBI on February 09, 2023 (SEBI | Consultation Paper on Review of Role and Obligations of Mutual Fund  Trustees) which discusses that while the MF Regulations over a period of time have cast various responsibilities over the Trustees, there are certain key areas which should be the focus for the Trustees and can be considered as their “core responsibilities” requiring independent due diligence and evaluation by the Trustees. The said core responsibilities have been identified keeping in mind the overarching role of Trustees to address any conflicts between interests of unit-holders and that of AMC’s stakeholders. The said paper also proposes that certain responsibilities of Trustees, being operational in nature, can be delegated to the Board of AMCs.

g. For Public Comments – Issue 7

i. Are the measures suggested at para 5.2.2 appropriate?

ii. Is the glide path suggested at para 5.2.2 appropriate?

iii. Whether additional certificate from Trustee or Board of AMC based on internal audit is required?

iv. If yes, whether the responsibility of addressing green-washing risks can be categorized as one of core responsibilities of the Trustees and whether they should carry out independent due diligence on the same?

v. Or, should only the Board of AMC be made responsible for certifying in this regard?

5.2.3 Classification of ESG schemes

a. Presently, Mutual Funds can launch only one ESG scheme under thematic category of Equity schemes. Considering that AMCs may want to launch multiple diversified ESG schemes under the ESG category, a new category for ESG schemes is proposed to be introduced. Thus, each AMC may be permitted to launch one ESG schemes each under following ESG sub­categories (indicative description at Annexure 3):

i. Exclusions

ii. Integration

iii. Best-in-class & Positive Screening

iv. Impact investing

v. Sustainable objectives

In this regard, the standardized criteria for different ESG strategies may be prescribed by Association of Mutual Funds in India (AMFI).

b. Further, ESG schemes under the proposed new category may be permitted with minimum 80% investment of total assets in equity/debt stocks of a particular theme as per the sub-categories. However, residual portion of the investment should not be starkly in contrast to the philosophy of the scheme from the theme. AMCs should endeavor to have a higher proportion of the assets under the ESG theme and make suitable disclosures.

c. For Public Comments – Issue 8

i. Whether a new category for ESG schemes should be introduced?

ii. Is the criteria for new category specified in the proposal appropriate?

5.2.4 Other proposals

a. Presently, the Mutual Funds are required to ensure that the name of the scheme accurately reflects the nature and extent of the scheme’s ESG focus taking into account investment objective and strategy followed. In this regard, to have increased transparency, it is proposed to mandate the AMCs to include the name of the particular ESG strategy in the name of the concerned fund/scheme. For example, XYZ ESG Exclusionary Fund, or ABC ESG Best-in-class Fund etc. This requirement may be made mandatory from April 01, 2023.

b. As mentioned at para 5.1.2 above, ESG schemes are required to use scores arrived at by AMFI empaneled ESG rating providers to publish securities wise score along with weighted average Fund Score in the monthly portfolio disclosures. However, disclosure of the name of rating provider is not mandated by SEBI. Thus, it is proposed to mandate ESG schemes to disclose name of the ESG rating provider alongside the score disclosures in the monthly portfolio disclosures. This requirement may be made mandatory from April 01, 2023.

c. Annual Fund Manager Commentary

i. It is proposed that under the Fund Disclosures, annually a section of ‘Fund Managers’ Commentary may be added which may highlight the following:

• Explanation of how ESG strategy is applied on the fund
• How engagements are carried out
• Any escalation strategy that the FM may have applied with respect to ESG factors on the portfolio companies
• Specific examples or comment on observations in the portfolio companies in the reporting year
• Annual tracking of ESG rating movements in the investee companies

ii. Further, with respect to annual tracking of ESG rating movement, as the ESG schemes may continue to have investments in companies where there is no BRSR disclosures till September 2023, the FM commentary should suitably disclose percentage of AUM invested in such companies and its impact, if any, on the Fund score.

iii. It is proposed to make disclosure of Annual FM Commentary from April 01, 2024 (i.e, for FY 2023-24) onwards.

d. For Public Comments – Issue 9

i. Are the proposals at paras 5.2.4 (a-c) appropriate?

ii. Is the implementation date(s) and/or glide path suggested appropriate?

6. Public Comments

6.1 Public Comments are invited on the above proposals. The comments / suggestions may be provided in MS Excel file, as per the format given below:

Name of entity /person /intermediary/Organization: Classification (Individual,    Intermediary,  Academic, Media, Law Firm, ERP, Corporate, Mutual Fund): Contact Details:
Sr. No.	Issue no. of    the Consultation Paper	Relevant Extract	Comments / Suggestions	Rationale

6.2 Comments may be sent on or before March 06, 2023 by email to consultationcfd@sebi.gov.in. While sending the email, kindly mention the subject as “Comments on Consultation Paper on ESG Disclosures, Ratings and Investing”.

Notes:

¹ https://www.sebi.gov.in/media/press-releases/may-2022/sebi-constitutes-advisory-committee-on-environmental-social-and-governance-esg-matters_58794.html

² Refer Annexure 1 for the format of the BRSR Core