Regulatory Framework of ESG Mutual Funds in India

ESG investment for sustainable finance

In recent decades, sustainability concerns have emerged as a key consideration across sectors, including the investment sector.ⁱ In the corporate context, sustainability is evaluated against environmental, social, and governance (ESG) standards, which assess a company’s environmental responsibilities, social contributions, and governance practices.ⁱⁱ

Investments in ESG began around 1960, when investors began avoiding tobacco-related stocks or the entire industry in South Africa.ⁱⁱⁱ Over time, alongside rising social and environmental concerns, the growing acknowledgement of the financial materiality of sustainability issues led to the launch of the United Nations Principles for Responsible Investing (UNPRI) in 2006.^iv This initiative provided asset owners with a formal framework for incorporating ESG standards into their investment decisions.^v

Mutual funds pool capital from a diverse group of investors and channel it into a range of securities, enabling investors to participate in large-scale and innovative investment opportunities. The first ESG mutual fund (MF) was launched in 1971 – the Pax Sustainable Allocation Fund – by Pax Worlds Funds in the United States (US).^vi In India, the first such fund was launched by the State Bank of India (SBI) in 2019 – the SBI Magnum Equity ESG Fund.^vii

Evolution and regulatory framework of ESG MFs in India

To support sustainable finance in India, the Securities Exchange Board of India (SEBI) has issued regulatory frameworks to streamline ESG disclosures, ESG ratings, and ESG investing. ESG disclosures have been mandated for the top 1,000 listed companies (by market capitalisation) from financial year (FY) 2023–24 under the updated Business Responsibility and Sustainability Reporting (BRSR) framework. This includes reasonable assurance/assessment of BRSR Core as per its glide path.^viii Guidelines have been instituted by SEBI for ESG rating providers (ERPs) to streamline ESG ratings.^ix These ESG investing guidelines have evolved through multiple consultations and amendments, as listed below.

In May 2022, SEBI constituted an ESG Advisory Committee (EAC) that sought public comments on ESG investing. This was followed by the publication of recommendations,^x wherein the Association of Mutual Funds in India (AMFI), in consultation with SEBI, established norms for ESG schemes of MFs. The norms included: (i) disclosure of the ESG focus in the scheme information document (SID); (ii) disclosures on engagements undertaken by asset management companies (AMCs) for ESG schemes; and (iii) general obligations related to sustainable finance.

In July 2023, to address the growing need for sustainable finance, SEBI issued a circular titled “New Category of Mutual Fund Schemes for Environmental, Social and Governance (‘ESG’) Investing and Related Disclosures by Mutual Funds”.^xi This circular laid down the key requirements for MF schemes to qualify as ESG MF schemes. The key provisions mentioned in the circular are as follows:

1. The circular introduced six scheme strategies in the ESG MF space. Previously, in the absence of multiple strategies, an AMC could issue only one ESG scheme. This circular allowed AMCs to introduce multiple ESG schemes, with clear distinctions in their investment strategies, asset allocation, etc. The strategies are as follows: 

• Exclusion: Based on ESG-related activities, business practices, or business segments
• Integration: Consideration of ESG-related factors material to the risk and return of investments, alongside traditional financial factors
• Best-in-class and positive screening: Investments in companies that perform better than their peers on any ESG parameter
• Impact investing: Investments aimed at generating positive and measurable social or environmental impact, alongside financial returns
• Sustainable objectives: Investments in industries, sectors, or companies expected to benefit in the long term from ESG trends
• Transition and transition-related investment: Investments in companies and issuers that support or facilitate environmental and just transitions

2. The circular also mandated a specific composition of assets under management (AUM) for such schemes. The applicability of disclosures is in accordance with SEBI’s July 2023 circular on the BRSR Core assurance framework:^xii

• AMCs are mandated to invest only in companies that provide BRSR disclosures.
• Of the total AUM, 65 per cent shall comprise investments in companies that provide BRSR Core assurances along with comprehensive BRSR disclosures.
• Of the total AUM, 80 per cent shall be invested in equity and equity-related instruments, in accordance with the scheme’s strategy.
• The remaining 20 per cent of the AUM shall not contradict the scheme’s strategy.

3. To prevent greenwashing, the circular established disclosure requirements for ESG schemes:

• Name of the strategy: The ESG strategy must be clearly disclosed by AMCs in the scheme’s name.
• ESG scores of securities: The BRSR and BRSR Core scores of the securities, as assigned by SEBI-registered ERPs, shall be published by AMCs in their monthly portfolio statements.
• Voting disclosures: 

1. AMCs shall compulsorily vote on all resolutions of their investee companies and disclose, on a quarterly basis, the rationale for their votes.
2. AMCs shall specifically disclose whether the resolutions were or were not supported for any ESG-related reason.
3. Voting disclosures must be made at the AMC level. However, in case of differences in voting strategies between ESG and non-ESG schemes, disclosures are to be made separately.

• Certification by the AMC board: The board shall certify the scheme’s regulatory compliance based on a comprehensive internal audit conducted annually.
• Assurance of ESG schemes: 

1. An independent yearly assurance on the AMC’s portfolio shall be obtained for being in compliance with the scheme’s strategy.
2. The annual fund manager (FM) commentary and disclosure shall include engagements undertaken for ESG schemes, examples of how the ESG strategy was applied, case studies on how FMs engaged with portfolio companies, annual tracking of ESG scores for investee companies, changes in ERPs, etc. 
3. Percentage of AUM invested in companies without BRSR reporting (prior to 1 October 2022), along with its impact.

ESG MFs are an important tool for channelling capital into sustainable finance. With an evolving regulatory framework, the ESG MF ecosystem in India is gradually gaining structure, transparency, and credibility, enabling investors to align their financial returns with long-term environmental and social outcomes. 

Who should care?

• Fund Managers
• Corporations
• Institutional investors
• Retail investors
• Regulators and policymakers