Policy brief on SEBI’s regulation for ESG rating providers

Abstract

The rise of sustainable finance and green investing has brought ESG, and by extension, ESG rating and providers, into the forefront. Policymakers have focused on regulating ESG rating providers (ERPs) over the past two years to increase confidence in markets and prevent greenwashing by rating providers.

We chart the development of these regulations by analysing the International Organization of Securities Commission’s (IOSCO) 2021 report and identify a framework of five themes that are prevalent in the regulatory space. These themes call for regulators to create policies around rating methodology, data and data sources, credibility, governance, and usability of ratings.

We use these themes to benchmark regulations in three peer jurisdictions – the European Union, the USA, and Japan. In the EU, we see heavy regulation as part of the Sustainable Finance Package aimed at improving transparency in ERP methodologies and their governance. In the USA, we see a focus on improving material disclosures by companies rather than regulating ERPs. We believe that regulation is a lower priority for the SEC, thereby opening room for manipulation and exploitation of ratings in the USA. Lastly, in Japan, we see a comply-or-explain code of conduct for ERPs, which is broadly aligned with the recommendations by IOSCO.

The benchmarking also helps us to draw out three key tradeoffs that policymakers face while drafting legislation in this space – standardisation vs. innovation, transparency vs competitiveness, and degree of regulation vs. cost of compliance.