With climate change getting serious attention, there is a reason all three strategic pillars of ESG – environmental, social, and governance – are interwoven. The G aspect of ESG is a tad understated.

An organisation might deliver on the environmental and social front by increasing energy efficiency and reducing carbon footprint and water consumption. However, the firm may have scope to bring its governance standards close to acceptable levels. For example, a lack of awareness of thorough regulatory practices could unwittingly lead to its downfall.

Before making investment decisions, it’s essential to scrutinise such companies. Are they in line with domestic compliance frameworks? It’s essential to educate investors on how ESG-oriented, independent boards are equipped for risk mitigation.

For now, the SEBI has announced various regulations to increase investors’ confidence in ESG schemes. First, ESG schemes are required to invest at least 65 per cent of AUM in listed entities where assurance on BRSR Core is undertaken. Third-party validation and certification from the board of AMCs will be mandated regarding compliance with the ESG scheme’s goal.Further, disclosure of case studies and fund manager commentary will be mandated. This regulation is essential to demonstrate how ESG strategy is used in the fund. Such processes assure that an ESG fund is not simply curated just on ESG scores.

Role of ratings

Even as SEBI continues to be investors’ watchdog, the role of ESG rating agencies has come into focus. Rating agencies adopt different practices when it comes to sharing individual E, S and G scores and making them public. Some ERPs provide ESG scores for each of the 3 dimensions along with an ESG score.

Similarly, several institutions provide risk ratings that measure the exposure and management of material ESG risks. Others provide separate ratings for governance and climate vulnerability.

Where responsibility is concerned, rating agencies are expected to assess a company’s overall ESG performance accurately. If a company falls short on governance but has good environmental and social performance, the rating should duly reflect on the overall score.

Everything depends on the rating agency’s methodology, data quality, transparency, and accountability. Ultimately, more standardisation ensures that ESG ratings are reliable, comparable, and meaningful.

An independent third-party rating helps investors gain confidence in a company’s ESG performance.

Fears of ESG-rating institutions being under pressure from big organisations to give better ratings are exaggerated.

Additionally, strong processes allow no gaps. Records are maintained at every stage. In the issuer-based ESG-rating model, the ratings are available in the public domain. A subscriber-based rating model, usually subscribed by banks and mutual fund houses, works better. Here, top companies don’t have to initiate the rating process by paying a rating fee to the rating provider. However, they can subscribe and get access to their reports if they are already rated. And that too after the rating was done. So, any conflict of interest in the business model of rating agencies is taken care of.

The effectiveness of ESG ratings lies in their completeness. Inconsistent and uneven metrics often end up misrepresenting it.

The writer is Chairman ESGrisk.ai and Group CEO Acuité