One man’s hero is another man’s zero: The story of ESG ratings in India

ESG and sustainable investing have gained more investor interest in the last two years, after the Covid-19 outbreak. Seven of the nine ESG funds in India were launched after 2020.
ESG and sustainable investing have gained more investor interest in the last two years, after the Covid-19 outbreak. Seven of the nine ESG funds in India were launched after 2020.


  • ESG rating providers have different methods and terminologies, and differ on what they see as important factors for their ESG ratings.

MUMBAI: ESG investing is still quite new in India, while globally assets managed under ESG-focused investments are estimated at over $30 trillion. ESG stands for incorporating environmental, social and governance standards into investing, and look for companies mindful of their impact on various stakeholders, and also how ESG issues can impact their own long-term growth and value.

In India, ESG funds today account for just 10,800 crore of investor assets. Bulk of these assets have come over last two years, with assets under management (AUM) seeing nearly four-fold jump.

ESG scores by rating agencies are used by institutional investors to understand the company’s standing on the ESG standards. But ESG ratings alone may not be the best indicator. As an ESG expert puts it, asset managers do their own due diligence and at times use ratings to engage with companies on any red flags.

Different approaches

With ESG ratings, there are differences in methodologies, as well as terminologies used by different rating agencies.

For example, MSCI uses a letter-grading system to differentiate companies that are leaders, average or laggards on their ESG scale. MSCI uses a 0-to-10 scale, which is divided into seven equal parts, each corresponding to a letter rating, ranging from AAA to CCC.

Crisil gives out an ESG score and puts companies into four categories -- leadership, strong, adequate or below average.

Morningstar Sustainalytics gives risk scores. The higher the risk scores, the worse is the company on its ESG scale.

Then there are also differences in what rating agencies see as significant factors to a company’s overall ESG score.

With ESG ratings, there are differences in methodologies, as well as terminologies used by different rating agencies.
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With ESG ratings, there are differences in methodologies, as well as terminologies used by different rating agencies.

Global vs local

Foreign ESG rating providers (ERPs) have put out ESG ratings for large- and mid-sized Indian companies, and domestic ERPs are in the process of covering top 1,000 Indian company by market capitalisation. This universe includes large-cap, mid-cap and small-cap companies.

Foreign rating providers tend to look at how the company is doing compared to other global entities in the same industry.

Indian rating agencies, on the other hand, consider the domestic peer group of the company.

“A domestic rating agency is likely to be more attuned to the nuances of the domestic market and the company’s progress on the ESG front within the domestic context," points out Priyanka Dhingra, ESG analyst at SBI Mutual Fund.

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“The realities of society in an emerging market will be different from those of the developed market," said senior executive of a fund house, requesting anonymity.

Take the case of the power utility company NTPC. While Morningstar Sustainalytics’ ESG Risk Rating flags the company as a high-risk, it has been graded as ‘Adequate’ by Crisil (see: table). NTPC has got CCC-grade by MSCI, which is its lowest ESG rating.

Clean power generation from renewable energy sources is a major focus area for NTPC and it plans to have 45% (65 gigawatt) of its overall power generation capacity from renewable energy sources. The company has already installed 23 solar power plants in the country, with plans to grow its hydro and wind-based energy projects.

Tata Power is another case in point. The company is flagged as a severe-risk company by Morningstar Sustainalytics, while it has been graded as ‘Strong’ by Crisil. MSCI has given it BBB-grade, which puts Tata Power in its ‘Average’ category.

This is despite Tata Power Solar, a wholly-owned subsidiary of Tata Power, being among the largest solar power producer in India.

“It also depends upon the policy thrust of the government. For a government in an emerging market economy, energy security and social welfare will be of higher priority and they may not penalise coal-based power generation, as much as US or Europe. ESG fund managers would look at government’s policy thrust and incorporate that in their investing process," says Sivananth Ramachandran, CFA Director, Capital Markets Policy, CFA Institute.

“But, the question is should the rating providers differentiate between a coal-based power company in India versus Europe. Or is it the job of fund manager to figure out what they want to do in that particular market," adds Ramachandran.

ESG Funds performance.
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ESG Funds performance.

Future of ratings

Experts say the difference in ratings can actually help asset managers to ask more questions from the company. “Unlike credit ratings which analyse different financial metrics of a company and also have a default event to benchmark the quality of ratings, ESG ratings analyse companies on various qualitative parameters. So, there are bound to be some differences between the ESG ratings of various agencies," points out Chandru Badrinarayanan, COO of Blue Sky Analytics and member of global policy and reference group of UNPRI.

UNPRI is a United Nations initiative, which lays down the six principles for responsible investment. The signatories commit to incorporating ESG issues into their “investment analysis and decision-making process".

Better disclosures by companies will also help ESG rating providers to make a better assessment of the companies on the ESG front. The level of disclosures by companies also impacts their ESG ratings.

From this financial year (FY23), it is mandatory for the top 1,000 companies by market capitalisation to make disclosures under Business Responsibility and Sustainability Report (BRSR). The disclosure rules were effective from last financial year, but were on a voluntary basis back then.

Under BRSR, listed companies are required to disclose their material ESG (environmental, social and governance) risks and opportunities, plans to mitigate the risks or adapt to them, as well as their financial implications.

In a consultation paper earlier this year, Indian market regulator Securities and Exchange Board of India (Sebi) said that while there were differences between ERPs in their terminologies and methodologies, it was important that the methodologies were clearly explained and disclosed, as well as the key performance drivers of their ratings, so that the investor could understand what was considered or excluded in the analysis.

The regulator has also proposed that for investors like mutual funds, ratings focused on ESG-related risks on company fundamentals might be more relevant than those focused on external impact. Sebi wants clear segregation of risk ratings as ‘ESG Corporate risk ratings’ or ‘ESG Financial risk ratings’, to distinguish from impact ratings.

In a separate consultation paper last year, Sebi had proposed that scheme information documents (SIDs) of ESG funds disclose if they are using any external ESG ratings and methodologies or following their internal frameworks.

Should you invest in ESG funds?

Differences in ESG ratings is not just in India, but also in the global market, where ESG is a fairly new investment strategy. A recent paper published by researchers from MIT and University of Zurich showed that correlation of ESG ratings between various global rating agencies was 0.38 to 0.71, with 1.00 indicating perfect correlation and -1.00 perfect negative correlation.

Amit Bhatia, founder, Aspire Circle and Aspire Impact, says “While our ESG rating systems have not yet fully settled down, India should think of taking the lead and leapfrogging to full impact to get ahead in the race. We have designed these standards with end-user ESG and Sustainability Impact in mind."

ESG and sustainable investing has gained more investor interest in the last two years, after the Covid-19 outbreak. Seven of the nine ESG funds in India were launched after 2020.

Given the differences in the ESG rating system and differing interpretation of ESG issues, ESG funds are likely to have varied portfolios and hence varied performances. As ESG funds are yet to build a long track record as a category, it would be better for investors to wait till a track record gets built.

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