Mint Explainer: What are ESG rating providers and why should investors care?

livemint.com:

VCs shift focus to ESG norms, not just ‘financial parameters’ for startup funding ESG ratings emerged as a response to the growing interest among investors and regulators in examining the wider impact of companies on all stakeholders. These ratings are an important gauge, especially for large funds that have various social or environmental mandates. ESG ratings are not standardised.

Every rating provider has different criteria and assigns different weights to environmental, social and governance aspects. This leads to a wide variance in the ESG scores, and raises concerns about their legitimacy and transparency. Also read: We should bridge the AI-human trust gap on ESG reporting Last year, Sebi set up a regulatory framework for ERPs in view of the growing importance of ESG ratings to investors.

Sebi noted that since ERPs were not subject to regulatory or supervisory oversight, “increasing reliance on such unregulated services in the securities markets raises concerns about the potential risks it poses to investor protection, efficiency of markets, risk pricing, capital allocation and greenwashing, among others". Greenwashing refers to providing false information about a firm's environmental credentials to mislead investors. Sebi rules allow ERPs in India to have one of two business models – issuer-pays or subscriber-pays.

Under the issuer-pays model, the company receiving the ESG rating pays the ERP, similar to the way companies engage credit-rating agencies. Under the subscriber-pays model, ERPscharge investors for access to the ESG ratings of the companies they cover. This is similar to the way proxy advisory firms charge institutions such as mutual funds and wealth funds to access their advisory reports.