SEBI Revolutionizes ESG Landscape: Mutual Funds Embrace Diverse Strategies and Rigorous Disclosures for Green Financing for ESG Thematic funds
Under the current rules, mutual funds are allowed to offer only one investment option (scheme) focused on ESG in the category related to stocks (Equity schemes). However, because there is a growing interest in environmentally friendly and socially responsible investments, and many people want to invest in different ways that align with ESG principles, there’s a request to change these rules.
In response to this request, it has been decided to allow mutual funds to launch multiple investment options (schemes) that focus on ESG, and these schemes can have different strategies for how they approach environmental, social, and governance considerations. This change aims to accommodate the increasing demand for investments that promote sustainability and ethical practices, often referred to as green financing.
ESG investments (Environmental, Social, and Governance) are becoming more popular. To make it easier for investors to understand and compare these investments, and to avoid misleading information (greenwashing), certain rules have been set by SEBI (Securities and Exchange Board of India).
SEBI sent letters to AMFI (Association of Mutual Funds in India) in February and June 2022, outlining disclosure rules for ESG schemes of Mutual Funds. These rules are available in the Master Circular on Mutual Funds dated May 19, 2023.
To improve transparency further and reduce the risks of mis-selling and greenwashing, SEBI formed an ESG Advisory Committee. This committee made suggestions for expanding the disclosure rules for ESG funds. After considering these recommendations and gathering public opinions, SEBI made changes to the regulations on June 27, 2023. One important change is that funds under ESG schemes must be invested according to SEBI’s specifications.
Accordingly, it has been decided to implement the following measures to facilitate green financing with thrust on enhanced disclosures and mitigation of green washing risk.
1. Thematic schemes on ESG Strategies:
Mutual funds are investment options that people can choose to invest in. ESG stands for Environmental, Social, and Governance, and it represents a type of investment that focuses on sustainability and ethical considerations.
Currently, mutual funds are allowed to offer only one ESG scheme (investment plan) under the thematic category of Equity schemes. However, a change has been decided. Now, a separate sub-category for ESG investments will be introduced under the thematic category of Equity schemes. This means mutual funds can have different ESG schemes with various strategies.
Any scheme falling under the ESG category will be initiated with one of the specified strategies (refer to Annexure A for strategy details) –
a. Exclusion
- Integration
- Best-in-class & Positive Screening
- Impact investing
- Sustainable objectives
- Transition or transition related investments
At least 80% of the money in these ESG schemes must be invested in stocks or related instruments that align with the chosen strategy. The rest of the investment should also be in line with the overall strategy of the scheme. Mutual funds are encouraged to invest a higher proportion of the assets in line with the ESG strategy and disclose this information to investors.
Asset Management Companies (AMCs), which manage these mutual funds, need to ensure that each scheme they launch is distinct in terms of where the money is invested and the overall strategy.
These new rules for creating a separate category for ESG schemes are effective immediately.
2. Criteria for Investing in ESG Schemes:
a. Current Rule:
Right now, ESG (Environmental, Social, and Governance) schemes of Mutual Funds are required to invest only in companies that provide detailed Business Responsibility and Sustainability Reporting (BRSR).
b. New Rule (Effective from October 01, 2024):
From October 01, 2024, it is decided that an ESG scheme must invest at least 65% of its assets (AUM) in companies that not only have comprehensive BRSR disclosures but also provide assurance on BRSR Core disclosures. BRSR Core disclosures are specific details outlined in a circular by SEBI.
The remaining assets of the scheme can be invested in companies that have BRSR disclosures (not necessarily providing assurance on BRSR Core).
c. Transition Period for Compliance (Until September 30, 2025):
If any ESG scheme doesn’t meet the new investment criteria by October 01, 2024, it has until September 30, 2025, to become compliant.
During this one-year transition period, ESG schemes that are not yet compliant should not make new investments in companies that do not provide assurance on BRSR Core.
3. Disclosure Requirements for ESG Schemes:
a. Naming of ESG Schemes:
Mutual Funds must clearly mention the ESG strategy in the name of their ESG fund. For example, if a fund follows an exclusionary strategy, it might be named XYZ ESG Exclusionary Strategy Fund, or if it follows a best-in-class strategy, it might be named ABC ESG Best-in-class Strategy Fund.
b. ESG Scores of Securities:
Mutual Funds offering ESG schemes need to include certain information in their monthly portfolio statements.
They should disclose security-wise BRSR Core scores (when available from SEBI-registered ESG Rating Providers), along with regular BRSR scores. These scores indicate how well companies are performing in terms of business responsibility and sustainability.
The name of the ESG Rating Providers that supply the ESG scores for the ESG schemes should be disclosed, along with the scores themselves. If there is a change in the ESG Rating Provider, the reason for the change must be disclosed in the next monthly portfolio statements.
These disclosure requirements are effective immediately, meaning mutual funds offering ESG schemes need to comply with them right away.
4. Voting Disclosures by ESG Schemes:
a. Existing Rule:
The SEBI Master Circular on Mutual Funds dated May 19, 2023, mandates that Mutual Funds must cast votes for all resolutions of the companies they invest in. Asset Management Companies (AMCs) are also required to disclose these votes on their websites every quarter. This disclosure should include the specific reasons supporting their voting decisions.
b. New Rule (Effective from FY 2024-25 – Annual General Meetings from April 01, 2024, Onwards):
To enhance transparency specifically for ESG schemes, it has been decided that, in addition to the existing requirements:
AMCs must clearly state in their voting disclosures whether the decision to support or oppose a resolution is influenced by environmental, social, or governance reasons.
The disclosure of the rationale behind voting decisions can be made at the Mutual Fund level. However, if the voting approach for ESG and non-ESG schemes within a Mutual Fund is different, the details and rationale for votes cast on behalf of ESG schemes and non-ESG schemes should be disclosed separately.
c. When the New Rule Applies:
These enhanced voting disclosures for ESG schemes will be applicable for the financial year 2024-25. This means they apply to Annual General Meetings held from April 01, 2024, onward.
5. Annual Fund Manager Commentary and Disclosure of Case Studies:
a. Annual Report Requirement (Effective from FY 2023-24):
Mutual Funds offering ESG schemes are required to include a ‘Fund Manager Commentary’ in the Annual Report of the ESG schemes. This commentary should provide additional details about the engagements undertaken by the Mutual Funds for ESG schemes, as mandated by SEBI in a letter dated February 08, 2022.
b. Contents of the Fund Manager Commentary:
The Fund Manager Commentary should include:
– Examples of how the ESG strategy was applied to the fund.
– Details about engagements, including any escalation strategy applied to portfolio companies.
– Annual tracking of ESG rating movements in the companies the fund has invested in.
– Case studies of specific engagements with portfolio companies, with objectives, actions taken, and outcomes achieved.
– Details about the number of engagements, communication methods used, and outcomes achieved (if any).
– Reporting on engagements and outcomes based on specific ESG objectives, if applicable.
– Annual tracking of ESG rating/score movements in investee companies.
c. Specific Disclosures in the Fund Manager Commentary:
The commentary should also disclose the percentage of Assets Under Management (AUM) invested in companies without BRSR disclosures (investments made before October 01, 2022) and its impact, if any, on the Fund’s score.
If there’s a change in the ESG Rating Provider (ERP), the reason for the change recorded by Asset Management Companies (AMCs) should be disclosed in the fund manager’s commentary.
Timeline for Additional Disclosures (Effective from FY 2024-25 and FY 2025-26):
The disclosure of case studies (as described in para (b) and (c) above) will be applicable from the financial year 2024-25.
Detailed engagement information will be disclosed starting from the financial year 2025-26.
6. Assurance on ESG Schemes – Independent Assurance:
a. Annual Independent Assurance:
Asset Management Companies (AMCs), which manage mutual funds, must get an independent and reasonable assurance every year to confirm that their ESG schemes’ portfolios follow the strategy and goals mentioned in the Scheme Information Documents.
b. “Comply or Explain” Basis for FY 2022-23:
For the financial year 2022-23, AMCs need to obtain this assurance by December 31, 2023. They can choose to either comply with this requirement or provide a reasonable explanation if they don’t.
c. Mandatory Disclosure in Annual Report:
Starting from the following financial years, it’s mandatory for AMCs to disclose this assurance in the annual report of the ESG scheme.
d. Board Responsibility for Assurance Provider:
The board of the AMC must make sure that the entity providing assurance for an ESG scheme has the necessary expertise to carry out a reasonable assurance.
e. Avoiding Conflict of Interest:
AMCs should ensure that there is no conflict of interest with the assurance provider. This means the assurance provider or any of its associates should not sell its products or offer any non-audit/non-assurance services, including consulting services, to the AMC or its group entities.
7. Certification by Board:
The board of directors of AMCs needs to certify the compliance of their ESG schemes with regulatory requirements, including disclosures. This certification is done based on a thorough internal ESG audit.
a. Internal ESG Audit:
The internal ESG audit involves a comprehensive review. It includes checking various documents like :
- Scheme Information Documents,
- Stewardship Reporting,
- Responsible Investment Policy of ESG Funds,
- and any other relevant document.
The aim is to ensure that the information provided in these documents is accurate and factual.
b. Applicability and Timeline:
This certification requirement is effective immediately. The board of directors must provide the certification for the financial year 2022-23 by December 31, 2023. After that, this certification should be disclosed in the Annual Reports of the schemes.
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