1. What is ESG Rating? How Banks Rely?

ESG Rating Agency - ERM - regulated from 2024:

• EU: EU ESG Rating Regulation - EU 2024/3005 - adopted Nov 2024, applies from mid-2026. First regulation in world to regulate ESG rating providers like Moody's, MSCI, S&P.
• India: SEBI Circular 4 July 2023 - ESG Rating Providers - ERPs - must be SEBI registered. BRSR Core assurance mandatory for top 1000 companies. SEBI acknowledges investors and ESG rating providers will depend on BRSR information.

Types:

• Double materiality - Impact + Financial
• Scores: 0-100, AAA-CCC
• Inputs: BRSR, CDP, Annual report, Media controversy

Reliance in Loans:

1. Sustainability Linked Loans - SLL: Margin ratchet linked to ESG rating - "If Sustainalytics Risk < 20, margin -10 bps"
2. Credit Risk Models: Banks using ESG score as overlay in internal rating model - Higher ESG score = lower PD?
3. Regulatory Capital / Fund Classification: SFDR Article 8/9 funds must hold assets with high ESG rating. Bank's treasury relies.
4. BRSR Assurance: BRSR framework has brought structure, and BRSR Core introduced specified metrics subject to assessment or assurance, as SEBI acknowledged that investors and ESG rating providers will depend on this information.

2. Why Reliance is Dangerous - 4 Problems

Problem 1: No Standard Methodology, Low Correlation
MSCI vs Sustainalytics vs S&P correlation ∼0.4 vs credit rating correlation 0.99. Same company: Tesla - MSCI AAA, Sustainalytics High Risk. Which is true?

Problem 2: Backward Looking, Company Paid?
Many ESG ratings are solicited - issuer pays - conflict. Others unsolicited based on public data only - can miss fraud.

Problem 3: ESG Scores do not aim to measure greenwashing risk

ESG scores produced by ratings agencies do not aim to measure these factors. Unmitigated, these risks expose companies and boards to claims of Greenwashing

Rating says low carbon risk, but company actually greenwashing - e.g., using carbon credits of no value.

Problem 4: Disclaimers - "For information only, not investment advice"

All ESG rating agencies have disclaimer: Not a guarantee, no liability. Similar to credit rating agencies pre-2008.

3. Liability Framework - Who is Liable?

A. Liability of ESG Rating Provider

EU New Regime - 2024 Regulation:

• Must be ESMA authorized
• Prohibited from providing consulting + rating to same entity - conflict
• Methodology public, must disclose data sources, limitations
• Liability for intentional or grossly negligent breach - Investor can sue for damages if relied and loss
• Similar to CRA III Regulation for credit ratings after financial crisis

India - SEBI ERP Regulations:

• ERP liable for faulty rating if not following stated methodology, not conducting due diligence on BRSR Core data
• Penalty, suspension, withdrawal

Case Law Analogy - Credit Rating Agencies:

• No direct Indian SC on ESG rating yet, but credit rating case law applied by analogy:

B. Liability of Bank / Fund that Relied and Sold as ESG

This is where major litigation is.

1. BNY Mellon Case - SEC - Tackling ESG Mislabels and Greenwashing

BNY Mellon is engaged in providing investment advice and fund management. Company had managed certain mutual funds from 2018 to 2021, over which it had claimed that ESG quality review had been undertaken on all investments. However, company had failed to undertake quality review

SEC charged BNY for misstatements and omissions about ESG considerations in making investment decisions. SEC charged BNY Mellon for misstatements and omissions about ESG considerations. BNY settled paying $1.5 mn penalty without admitting wrongdoing.

Principle: If you market fund as ESG reviewed based on ESG rating, but you don't actually review rating methodology, you are liable for greenwashing.

2. Goldman Sachs Asset Management - SEC Nov 2022 - $4 million

SEC settled enforcement for 4 million dollars - Goldman claimed ESG funds had ESG review, but failed to have written policies. Same pattern.

3. Vanguard Investments Australia - ASIC v Vanguard (No 2) FCA 1086 - $12.9m[2024]

Federal Court has imposed a $12.9 million penalty on Vanguard Investments Australia Ltd for making misleading environmental, social and governance ESG claims. Greenwashing is key enforcement priority for ACCC and ASIC.

Facts: Vanguard claimed ESG fund excluded tobacco, fossil fuel based on ESG screening. Actually 42 securities out of 400+ in fund breached screening because ESG rating provider error. Vanguard admitted.

Court: Even if reliance on ESG rating provider, fund manager remains liable. Cannot outsource liability to ESG rating agency. Penalty $12.9m.

Most important for banks.

4. ASIC v LGSS Pty Ltd FCA 587 - Active Super[2024]

ASIC alleged defendant as trustee for Active Super superannuation fund contravened sections 12DB(1)(a) and 12DF - Greenwashing

Active Super marketed as ESG, but held coal mining, oil sands, Russian companies. Defence: ESG rating said it was ESG.

Court: Trustee liable. ESG rating not defence. Must do own due diligence.

5. UK FSMA Section 90 & 90A Claims - Professional Advisors

Sections 90 and 90A FSMA provide causes of action through which shareholders may hold public companies accountable for misleading statements in published information

ACL Netherlands v Lynch case highlighted high evidential burden. Now applied to ESG disclosures. If auditor or advisor assisted in ESG disclosure based on ESG rating without verification, can be sued for professional negligence.

Stephenson Harwood note:

Potential Cause 5: Professional negligence arising from greenwashing - Negligence claims against professionals are common

6. India - Greenwashing Liability - Emerging

• SEBI PFUTP Regulations 2003 - False ESG metrics can distort capital allocation just as material misstatements in financial statements do. This reliance standard evident in SEBI's 12 Aug 2025 order concerning Dewan Housing Finance.

SEBI can initiate PFUTP for BRSR greenwashing.

Central Consumer Protection Authority greenwashing guidelines notified Oct 2024 under Consumer Protection Act 2019 require environmental claims be substantiated with verifiable evidence and restrict vague terms - If bank advertises "Green Home Loan based on ESG rating" but cannot substantiate, CCPA can penalize.

Companies Act Sec 339 + SEBI Act Sec 11B - Personal Liability for Promoters in ESG Failures: Beyond Corporate Veil

Section 339 enables courts to hold officers personally liable for fraudulent trading. SEBI Act Sections 11, 11B provide disgorgement and penalty authority directly against individuals, not just companies, for disclosure failures.

So promoter personally liable if relied on false ESG rating to get loan at lower margin.

7. Landmark ESG Liability Cases - Applied by Analogy

• Client Earth v Shell plc UK 2023 - Court said directors' duties under s172 Companies Act 2006 include ESG. If directors blindly rely on ESG rating without inquiry, breach duty of care.
• Milieudefensie et al v Royal Dutch Shell Netherlands 2021 - Court referred to UNGPs as authoritative soft law, found company liable for climate harm despite having good ESG rating. Rating not defence.
• Lliuya v RWE Germany - Higher Regional Court Hamm - Recognised major GHG emitters can be held liable under German civil law for climate harms - Even if ESG rating high.

4. Consequences of Blind Reliance on ESG Rating in Loans

For Bank Lender:

1. Greenwashing Regulatory Fine - FCA anti-greenwashing rule effective 31 May 2024 - Makes it actionable misconduct for FCA-authorised firm to make misleading ESG claim - Based on ESG rating that is flawed.
2. Loan Mis-selling - Borrower can claim bank misrepresented loan as cheaper if ESG rating high - When rating falls, margin jumps - Borrower sues for mis-selling if bank did not explain rating methodology.
3. SFDR Reclassification - If fund classified Article 9 based on ESG rating, and rating downgraded, fund must sell loan at loss - Investor can sue manager for reliance.
4. Credit Loss - ESG rating said low transition risk, but company actually high carbon stranded asset - Default - Bank cannot sue rating agency due to disclaimer, bears loss.

5. How to Mitigate Liability - Best Practice

For Banks / Funds Relying:

• Never link loan pricing solely to external ESG rating - Use internal verified KPI - SLLP recommends KPIs not ratings
• Include Disclaimer Override: "Borrower acknowledges ESG rating provider is independent, Lender does not warrant accuracy of rating, Borrower responsible for own ESG performance"
• Require Second Party Opinion + External Assurance on BRSR Core - Not just rating
• Contractual right to challenge rating - If rating methodology changes, allow renegotiation
• Under EU 2024 Regulation, get right to audit ESG rating provider methodology

For ESG Rating Providers:

• ESMA authorization, publish methodology, manage conflicts, maintain insurance
• Provide explicit limitation: "Rating based on public info as of date, not assurance of future ESG performance"