The Securities and Exchange Board of India (SEBI) notified the SEBI (Mutual Funds) (Second Amendment) Regulations, 2023 on 27 June 2023, amending the SEBI (Mutual Funds) Regulations, 1996 to establish a regulatory framework for Environmental, Social, and Governance (ESG) mutual fund schemes. The amendment mandates that funds classified under ESG categories invest in the manner specified by SEBI and comply with enhanced disclosure norms related to sustainability parameters.
Background
India's mutual fund industry had seen growing investor interest in ESG-themed investments, with multiple AMCs launching ESG-focused schemes. However, the absence of a standardised regulatory framework raised concerns about "greenwashing" — the practice of marketing funds as sustainable without meaningful ESG integration in the investment process.
SEBI had released a consultation paper on ESG disclosures in February 2023, seeking stakeholder feedback on proposed disclosure requirements for ESG-rated issuers and ESG mutual fund schemes. The June 2023 amendment to the Mutual Funds Regulations represented the first step in codifying these requirements into the formal regulatory framework.
Key Provisions
The amendment introduces the following regulatory requirements:
Investment mandate for ESG schemes: Mutual fund schemes categorised as ESG funds must invest at least 65 percent of their corpus in securities meeting ESG criteria as specified by SEBI. The specific investment methodology and ESG scoring framework would be detailed in a subsequent circular.
Disclosure requirements: AMCs operating ESG schemes must provide enhanced disclosures on the ESG methodologies employed, the rating agencies or assessment frameworks used, and the portfolio's alignment with stated ESG objectives.
Fund manager qualifications: ESG scheme fund managers must demonstrate competence in ESG analysis and sustainable investing, with AMCs required to provide adequate training and resources for ESG integration.
Third-party ESG ratings: The amendment laid the groundwork for SEBI to prescribe norms for ESG Rating Providers, addressing conflicts of interest, methodology transparency, and rating quality.
Investor communication: Scheme Information Documents and Key Information Memoranda for ESG funds must clearly articulate the ESG investment strategy, including exclusion criteria, engagement approach, and impact metrics.
Implications for Practitioners
Capital markets lawyers advising AMCs must closely track the implementation circulars that will follow this regulatory amendment. The 65 percent investment mandate creates a binding portfolio construction constraint that fund managers must operationalise immediately for existing ESG schemes.
Compliance teams at mutual fund houses should prepare for enhanced scrutiny of ESG claims. The anti-greenwashing intent behind these regulations means that regulators will examine whether ESG schemes genuinely integrate sustainability factors or merely use ESG labels for marketing purposes.
For practitioners advising ESG Rating Providers, the regulatory framework creates both opportunity and compliance obligations. SEBI's move to regulate ESG ratings brings India in line with global regulatory trends, particularly the EU's ESG ratings regulation proposals. Providers must prepare for methodology disclosure and conflict-of-interest management requirements.
Investment advisors should update their client suitability frameworks to incorporate the new ESG scheme classification and disclosure standards.