It's Time India Developed A Homegrown, Credible ESG Ratings Ecosystem

Cut to 2024, and the capitalist system is keen on marketing itself as sustainable, not just because of good-natured altruism or its attractiveness to consumers and the workforce, but because it helps the bottom-line for businesses, as reported by market data and BCG analysis.

“We focus on sustainability not because we’re environmentalists, but because we are capitalists and fiduciaries to our clients,” says Larry Fink, CEO, BlackRock, which is the largest global asset management company with US$ 10 trillion in assets.

In this economic and marketing environment, governance and assessment of sustainability efforts through ESG ratings services have become so integral to the corporate sustainability ecosystem that it has a global market size of about US$ 10 billion per industry reports.

The Indian Setting

In India, two key regulations have set the stage for higher transparency in double materiality issues through a focus on ESG reporting in recent years. The Business Responsibility and Sustainability Reporting (BRSR) Framework of 2021 and SEBI’s Draft Regulatory Framework for ESG Rating Providers (ERPs) from 2023 amalgamate strategically to fulfil a common goal.

First, the former mandates robustness in sustainability issues through regular disclosures from the top 1,000 listed companies and the latter regulation then has the opportunity to assess the strengths and weaknesses of ESG management as well as accountability within these corporations.

The Draft ERP Regulation is an intervention in the corporate responsibility assessment segment, as India joins the few jurisdictions globally to regulate the sector, along with developed economies such as the EU, UK, USA, and Singapore.

It is an attempt to tap into the corporate responsibility disclosure pulse, which is estimated to have seen a 160 per cent surge in reporting between 2020 and 2022 in India’s top 1000 listed companies.

However, with regulations ushering in the objective of corporate accountability, the ESG ratings sector itself is underdeveloped compared to global peers when it comes to homegrown companies.

Since this segment’s credibility and quality are its core selling point for stakeholders, building a homegrown ESG ratings brand is a typical hurdle for entrepreneurs. CRISIL, the most well-known player in this sector within India, also operates as a subsidiary of S&P Global, and other credible ratings providers like the Economic Times Intelligence Group, as well as the ICRA, are new to the sector, with the latter moving in as recently as September 2023.

But the question of the hour is: Why does India need these homegrown companies in the first place? Established global agencies such as MSCI, Sustainalytics, CDP, and Bloomberg, among others, have a strong foothold in the space.

In fact, ESG scores continue to influence investor decisions, with chief investment officers of long-horizon equity funds claiming they are “prepared to pay a premium for companies that show a clear link between their ESG efforts and financial performance”.

The Case For A Homegrown ERP Ecosystem

A former analyst at a global ESG rating agency explained on the condition of anonymity that with the same performance across an estimated 95 per cent of material ESG variables, a benchmark across developed and emerging markets is likely to attribute lower scores to emerging market players.

Analyses have shown that companies based out of G20 nations averaged a score of 64 in an environmental index by Refinitiv, according to indicators available in the public domain.

Furthermore, several reports highlight how ESG fund flows are blocked to these players as “dominant ESG scores can penalise developing market companies for their ‘country risk’” based on political and national debt factors.

Experts at management consultancies such as the Boston Consulting Group won't confirm that emerging markets are penalised, but they cite reasons for their underperformance.

Companies in developed markets had a big head start. They began launching sustainability initiatives decades earlier in response to intensifying pressure from regulators and civil society.

Another important reason for a homegrown market in this sector is the scale in India: India alone is home to 1.5 million registered companies. Global ratings providers such as MSCI, CSRHub, Sustainalytics can't deal with so many; they rate and aggregate sustainability information for some 11,000 to 18,000 companies each currently.

As the ambit of the BRSR framework and other disclosure laws expands, private companies as well as SMEs are bound to get into the CSR narrative strategy game. They would want to compete and lead in the market, instead of merely complying, with an attempt at transparency. Therefore, any scrutiny-oriented objective spotlight in the sustainability risk and impact assessment space needs to have a diligent focus on the Indian market with a strong command of its socio-economic pulse.

Lessons From Gaps in Global ESG Rankings

While there is considerable merit in adopting global best practices for consistency in these ratings, the methodology itself is far from uniform. Agencies have distinct rating methodologies, wherein every agency has its own set of analysts and algorithms to evaluate ESG metrics in the form of disclosures. The broader scope of governance questions, sustainability targets and initiatives, as well as double materiality assessment of risk and impact may apply, but the weightage and specific nuances vary significantly.

Even if industry standards and regulatory interventions improve upon this lack of transparent uniformity in the coming years, the discrepancy in ESG narrative strategies as publicised by corporations and their on-ground implementation may still remain unresolved.

Sanjay Joshie, Head of Climate Change, Agriculture, and Livelihoods at a Delhi-based non-profit ECHO, notes that in India, “ESG ratings are the second highest driver after regulations to promote good ESG practices”.

But he feels the effective implementation of CSR policies remains a critical issue as the most effective strategies and initiatives may not be adopted across all company sites. “They adopt the best practices in one or two locations and keep showcasing that,” Joshie adds.

However one perceives the modus operandi of the ESG ratings landscape, it will continue to influence the sustainability discourse and market.

For India, forecasted to add the largest share of global emissions by 2050, the most pragmatic and foresighted course of action may be to not just be seated at the table but also have shining examples to share on the crucial implementation and assessment of CSR and its impact.

(The author is a climate and sustainability researcher at the Boston Consulting Group in India. Views expressed are personal)