Effectiveness of ESG Rating Schemes in Capturing Impact Monitoring and Assessment

Over the last decade, Environmental, Social, and Governance (ESG) principles have rapidly moved from the sidelines of corporate responsibility to the center of financial decision making, brand strategy, and policy planning. Environmental, Social, and Governance (ESG) frameworks have become a cornerstone of corporate strategy and financial decision making. From boardrooms to trading floors, ESG metrics now influence everything from investor preferences to regulatory audits. ESG rating agencies such as MSCI Inc. , Morningstar Sustainalytics , S&P Global , and Refinitiv have emerged as gatekeepers in evaluating sustainability performance. Companies across sectors now wear ESG badges with pride, and investors increasingly rely on ESG ratings to guide where their money goes. Governments, too, are weaving ESG elements into public policy frameworks. This widespread attention signals a growing global desire to promote ethical governance, reduce environmental damage, and address social inequalities. But as this enthusiasm grows, so does a critical question: Are ESG rating schemes truly capturing the real impact companies and institutions are having on the world or are they simply offering a convenient way to look responsible without being held accountable?

In this debate a mismatch between intentions and outcomes arises quite often. ESG rating systems were introduced with the goal of offering a simplified, standardized way to evaluate how responsibly an organization operates. But in practice, they have often ended up rewarding how well a company presents itself, rather than what it actually does. Many ESG ratings are based on self-reported data, forward looking commitments, and risk assessments rather than hard evidence of social or environmental impact. As a result, companies that are highly skilled at compliance, documentation, and optics often score better than those quietly making meaningful progress without the same reporting infrastructure. This leads to a situation where ratings reflect preparedness on paper, not progress in practice at ground level.

The ripple effects of this are significant. ESG scores now influence investment decisions worth billions of dollars, shape corporate reputations, and increasingly drive access to funding especially through mechanisms like green bonds, ESG linked loans, and sustainable indexes. When these ratings fail to represent real world outcomes, the consequences stretch far beyond the companies themselves. Capital may flow toward well branded performers instead of high impact change makers. Policymakers may rely on inaccurate indicators to shape guidelines and regulations. And stakeholders be it consumers, employees, or communities may be misled about which organizations are genuinely contributing to sustainability and equity. In other words, the illusion of progress can easily replace the urgency for actual change.

This disconnect between appearance and impact creates a systemic challenge, particularly in a world where climate change, resource scarcity, and social injustice are becoming more severe and visible. It risks turning ESG into a performance well-rehearsed, beautifully staged, but detached from reality. The cause of this lies not only in the tools themselves but also in the lack of alignment between ESG methodologies and ground level realities. When ESG becomes a checkbox exercise rather than a meaningful process of reflection, reform, and accountability, its credibility and usefulness are both put at risk.

Generally, the ESG performance of any organization is assessed using a variety of tools, each with a different focus and function. These tools fall into three categories: ratings, disclosures, and rankings.

·       Ratings assign a score or grade (e.g., AAA to CCC or low to severe risk) based on ESG risk exposure and management capacity. Examples include MSCI ESG Ratings and Sustainalytics Risk Ratings. These are mostly designed for investors and rely heavily on corporate disclosures.

·       Disclosures are structured reporting frameworks, such as the Global Reporting Initiative (GRI), Task Force on Climate related Financial Disclosures (TCFD), Sustainability Accounting Standards Board (SASB), and India's Business Responsibility and Sustainability Report (BRSR). These frameworks do not rate or rank companies but guide them to report data in a comparable manner.

·       Rankings, like the Corporate Knights Global 100 or Dow Jones Sustainability Index (DJSI), compare companies based on sustainability performance and are often used in media or public rankings. They tend to focus on leadership and best practices rather than broad based scoring.

Most ESG ratings are risk centric, evaluating how ESG issues affect a firm’s financial value not how the firm affects the world. For instance, an oil company with robust disclosure practices and risk management systems may score high on ESG, despite continuing to expand fossil fuel production. The issue lies in financial materiality bias. ESG ratings often ignore broader ecological or social outcomes if they are deemed financially immaterial. This disconnect weakens the ability of ESG ratings to serve as reliable tools for impact investing capital deployment intended to achieve measurable social and environmental benefits alongside financial returns. Moreover, divergence in ESG ratings across agencies creates confusion. A firm may be rated highly by one agency and poorly by another due to differing methodologies, weightings, and data sources. This challenges the credibility of ESG scores as consistent investment signals and hampers efforts to align portfolios with real world sustainability objectives. For corporations, ESG ratings are now tightly linked to public perception, brand equity, and stakeholder trust. Many firms actively pursue high ESG scores to improve their standing among consumers, talent pools, and investors. However, this often incentivizes a culture of disclosure optimization rather than impact performance.

Companies may channel resources into elaborate sustainability reports, ESG communications, and third party certifications while continuing unsustainable practices. This phenomenon sometimes referred to as “Greenwashing by Compliance” which is facilitated by the current structure of ESG ratings; which frequently reward the existence of policies over the demonstration of outcomes. In practice, this creates a scenario where large, well-resourced companies can secure favorable ESG scores through sophisticated disclosures, while smaller or impact focused companies lacking robust reporting infrastructure are penalized. Consequently, ESG ratings may help corporate reputations that are not actually earned, masking the true sustainability impact of firms and misleading stakeholders. Regulators are increasingly incorporating ESG metrics into reporting mandates, green finance guidelines, and corporate governance frameworks. ESG ratings, in turn, are often used to demonstrate compliance or eligibility for incentives, such as access to sustainable finance instruments (e.g., green bonds or sustainability linked loans).

For a layman, ESG ratings are private sector tools and not standardized public regulations. As such, there is no uniform methodology across ESG providers, no centralized data repository, and limited regulatory oversight over how ratings are developed or applied. Furthermore, most ESG rating schemes do not incorporate third party impact verification, nor do they require alignment with scientifically grounded targets such as those set by the @Paris Agreement or the UN Sustainable Development Group . This makes them insufficient as standalone tools for robust compliance or as credible indicators of a company’s contribution to national and international sustainability goals. To address this, regulators in the EU and global standard setters like the International Sustainability Standards Board (ISSB) and EFRAG are working to improve ESG disclosure requirements and ensure that ESG metrics align with impact materiality. However, these efforts remain in development and are yet to be mainstreamed into private ESG scoring methodologies.

Another issue is that traditional ESG ratings such as those produced by MSCI, Sustainalytics, and S&P Global primarily evaluate how well companies manage ESG risks that could affect their financial performance. These risk based ratings tend to focus on policies, disclosures, and governance mechanisms. While useful for investors seeking to avoid ESG related liabilities, they fall short of capturing real world, on the ground outcomes. The ESG ratings ecosystem includes several major agencies, each with a distinct method and scope.

·       MSCI ESG Ratings score companies from AAA to CCC and emphasize industry relative risk management.

·       Sustainalytics offers risk scores from 0–100, focusing on financially material risks, while also supporting controversy ratings to flag reputational issues.

·       S&P Global ESG Scores, derived from its Corporate Sustainability Assessment, place a strong focus on disclosure quality and governance practices.

·       Moody's Ratings's ESG Solutions evaluates impact materiality with a score from 0–100, often integrating ESG into credit assessments.

·       ISS ESG Ratings bring sector specific ability, particularly in governance, while combining theme specific scores with controversy analysis.

Complementary global benchmarks such as CDP (A to D  grades), GRESB (for real estate and infrastructure, with peer benchmarking), and Bloomberg ESG Disclosure Scores (0–100 based on reporting completeness) provide varied levels of insight into sustainability performance. Meanwhile, Refinitiv ESG Scores offer both numerical and letter grades based on disclosure across ten themes. Importantly, the International Sustainability Standards Board (ISSB) is not a rater, but its standards (IFRS S1 and S2) are poised to unify disclosure expectations globally. These schemes are evolving to better reflect performance, but inconsistencies in rating methodologies, limited third party validation, and overreliance on self-reported data still limit their credibility in capturing impact.

Company Image

Over the last decade, many companies have used high ESG scores to build a public image of responsibility and leadership. However, this can backfire when ratings mask harmful practices. A notable example is Volkswagen Group’s emissions scandal, where the company was initially considered a sustainability leader due to its innovation in clean diesel technology and transparent reporting. It had high ESG scores from several agencies. Yet, it was later discovered that Volkswagen had installed software to cheat emissions tests in over 11 million vehicles globally. The fallout was immense billions in fines, legal charges, and a shattered public image. This example highlights a key risk regarding the ESG rating’s reward policy being a mere presence rather than performance, allowing companies to curate an image that misleads regulators, consumers, and investors alike. More recently, Adani Group faced reputational scrutiny in after a report accusing the company of stock manipulation and accounting irregularities. Despite scoring reasonably well on some ESG platforms for infrastructure resilience and environmental planning, the controversy revealed how governance lapses and lack of transparency can remain hidden behind good ratings. The risk here is that ESG ratings especially when they are non-transparent or unverified can be misused to enhance image, even when fundamental ethical issues persist. This can leave companies vulnerable to reputational collapse once the truth surfaces.

Investor Confidence

In the financial sector, the role of ESG ratings becomes even more complex. Banks, investors, and insurers use ESG scores to assess both their own operations and the companies they finance or insure. While financial institutions may score well for internal policies such as sustainable investing guidelines or green lending frameworks these scores do not always account for the ESG impacts of the portfolios they manage. A bank might have strong ESG disclosure practices, yet continue financing coal, weapons manufacturing, or projects that displace communities. Current ESG rating schemes often fail to evaluate the downstream or financed emissions and social impacts of such institutions. As a result, these ratings may paint a misleading picture suggesting an institution is ESG aligned while its capital flows still support environmentally or socially harmful activities. Recently, there have been moves toward including metrics such as portfolio emissions, sectoral lending exposure, and ESG screening practices in financial ESG assessments. One of the main reasons ESG ratings exist is to help investors make better decisions. But when these scores fail to reflect actual risks, investors may unknowingly back harmful or unstable companies. A classic example is the inclusion of Wirecard, a German payment processor, in several ESG focused investment indices before its collapse due to billions in an accounting fraud. Wirecard had positive governance scores due to board structure and regulatory filings yet failed to capture the systemic financial misconduct within the company. Investors, relying on ESG credentials, were blindsided by the scandal. In the Indian context, YES BANK was long celebrated for its ESG friendly lending practices and was included in sustainable indices. However, behind the curtain, the bank had mounting exposure to stressed assets and questionable governance. The bank collapsed into a fiscal crisis, requiring an emergency rescue led by the Reserve Bank of India (RBI) and State Bank of India. ESG scores had not flagged the quality of lending or underlying risks, pointing to a structural gap between ESG indicators and deeper financial governance issues. These examples show that when ESG ratings are too focused on surface level metrics, such as sustainability reports and diversity policies, they may miss deeper systemic risks. This can mislead investors into supporting businesses that are either financially unstable or socially harmful ironically undermining the very goal of sustainable investing. However, these are still evolving, and rating systems have yet to fully incorporate these dimensions in a standardized, robust manner.

Customer Response

Consumers increasingly use ESG signals to guide their choices. A strong ESG reputation can boost brand loyalty, especially among younger, environmentally conscious audiences. But when the reality does not match the ratings, customer backlash can be swift and brutal. The case of H&M and "Conscious Collection," which was marketed as a sustainable clothing line, the company scored well on several ESG metrics related to transparency and circularity. However, an investigation it was found that the claims were vague and unsubstantiated, leading to accusations of greenwashing. Consumers felt misled, and trust in the brand’s sustainability claims took a hit. This reflects a growing risk if ESG ratings enable companies to overstate their sustainability credentials, the reputational damage can be more costly than the short term image boost. In India, Vedanta Group faced similar scrutiny, where its copper smelter despite having strong documentation of environmental compliance was linked to local pollution and health issues. Public outrage led to protests and eventually the plant’s shutdown by the Tamil Nadu government. ESG ratings had not captured community sentiment or environmental impact beyond official filings. As consumers and civil society groups grow more vigilant, companies that rely on ESG scores without addressing on ground realities risk losing their social license to operate.

Urban Managers and Governments: The Missing Dimension

Urban authorities and public sector bodies are increasingly engaging with ESG principles whether through green bonds, smart city projects, or climate adaptation plans. Yet, traditional ESG ratings are not always designed to evaluate public institutions. When municipalities or urban development agencies are rated, it is often through separate indices like the GRESB or climate specific benchmarks like CDP Cities. For government bodies, the challenge is twofold. First, many ESG rating schemes do not adequately reflect the complexity of public service delivery and long term social value. Second, they often rely on disclosure and short term metrics, which do not capture the depth of public impact, equity outcomes, or intergenerational sustainability. For example, an urban authority may receive credit for publishing a climate plan, but not be penalized for failing to implement measures that benefit low income or vulnerable communities. Furthermore, governments are often constrained by public procurement rules, budget cycles, and political pressures, which ESG rating schemes do not account for. Impact monitoring in public systems must be more inclusive and rooted in context specific outcomes, such as improved access to services, reduced air pollution, or resilience to natural disasters. ESG ratings, as they stand today, are not fully equipped to measure these.

ESG as a Strategic Assessment Tool

The true potential of ESG ratings becomes evident when companies use them not just to fulfill disclosure requirements but to fuel strategic transformation. Indian companies are demonstrating how ESG metrics can drive innovation, influence leadership decisions, and strengthen trust across stakeholders.

Infosys uses ESG scores to drive energy efficiency, reduce carbon footprint, and invest in circular economy practices. By achieving 100% renewable electricity use and maintaining zero waste to landfill, the company has operationalized ESG goals into its business model. The inclusion of these metrics in C suite dashboards has helped leadership allocate budgets to retrofitting data centers, launching inclusive hiring programs, and benchmarking global progress. These improvements enhance investor confidence, employee morale, and brand credibility. HDFC Bank has embedded ESG scores into its credit and risk systems, allowing the bank to prioritize climate aligned sectors. Green financing has become a core strategy, with sustainability linked loans and ESG funds driving value. ESG scores influence internal capital allocation and inform investor roadshows, reinforcing the bank's commitment to sustainable development finance. Tata Steel illustrates how ESG is not just a reporting tool but a research and innovation lever. The company's ESG ratings are tied to long term decarbonization goals. Investments in hydrogen based steel manufacturing, electric arc furnaces, and scrap recycling have been validated by ESG data and further enabled by high ESG performance that supports funding access and stakeholder buy in. Godrej Properties Limited uses GRESB benchmarks to set annual ESG performance targets across projects. Its site level teams use these indicators to improve water harvesting, construction waste recycling, and community health outcomes. These improvements are captured in ESG reports that enhance the company’s attractiveness to impact investors and real estate buyers. Wipro connects ESG to employee performance, executive bonuses, and supply chain engagement. Its ESG linked procurement practices and carbon pricing strategy are derived directly from sustainability ratings. The company’s strong ESG reputation helps it win green IT contracts and attract socially conscious tech talent, further reinforcing its competitive edge. Collectively, these examples demonstrate how ESG metrics can evolve into powerful tools for internal transformation, external communication, and stakeholder alignment beyond just compliance.

Startups in India are integrating ESG principles as a part of their core identity rather than as an afterthought. Unlike legacy firms, startups are increasingly founded with the intention to solve climate, inclusion, or governance challenges. Take the case of Ecozen , a cleantech startup offering solar powered cold storage solutions to farmers. Their business addresses core ESG concerns: environmentally, they reduce carbon emissions through renewable energy; socially, they help smallholder farmers reduce crop losses and boost income; and from a governance perspective, they maintain detailed impact dashboards to report performance to investors. Their alignment with sustainable agriculture has attracted funding from Asian Development Bank (ADB) Ventures and impact investors like Omnivore. Similarly, Recykal.com, a digital waste management platform, is leading circular economy initiatives by connecting waste generators with authorized recyclers and processors. Their impact is measurable because hundreds of tonnes of plastic waste diverted from landfills, and FMCG brands enabled to meet Extended Producer Responsibility (EPR) goals. However, many startups struggle with structured ESG reporting due to limited resources. Their impact is real, but documentation is informal, making it difficult to be recognized by ESG rating providers. What they need are sector relevant ESG frameworks, simplified indicators, and tools that balance rigor with accessibility.

India’s government has not formally labeled many of its programs as ESG, but its policies consistently mirror ESG goals particularly through flagship schemes that embed sustainability, inclusion, and transparency. The Smart Cities Mission, launched in 2015, exemplifies ESG alignment. Environmentally, cities like Pune and Surat are retrofitting energy efficient lighting, rainwater harvesting systems, and EV friendly public transport. Socially, the program prioritizes inclusive public spaces and digitized civic services. Governance wise, real time dashboards and participatory budgeting tools have been deployed to enhance transparency and citizen engagement. Pune and Indore and Ahmedabad have even issued green municipal bonds, linking urban finance to ESG principles. The Jal Jeevan Mission, aimed at ensuring functional tap water in rural households, is a stellar example of an ESG integrated public program. Environmentally, it promotes water conservation and greywater reuse. Socially, it enhances health outcomes and eases the burden on women who traditionally collect water. Governance wise, it leverages performance based funding and digital monitoring tools to improve accountability. The Government’s 2023 issuance of Sovereign Green Bonds was another milestone. These bonds will fund clean energy, afforestation, and resilient infrastructure, with proceeds tracked under a Green Bond Framework aligned with ICMA principles. Though India lacks a full ESG taxonomy, these steps demonstrate serious intent to mainstream ESG into national financing and policy tools.

On the NGO front, Pratham Education Foundation India’s largest education NGO exemplifies ESG in a social context. Pratham contributes to SDGs on education, gender equity, and economic opportunity. While not a corporate entity, its transparent reporting, community centric programming, and focus on measurable outcomes align closely with ESG frameworks. Public private partnerships like the Skill India Mission show how ESG can function as a bridge. Firms like Infosys and Maruti Suzuki India Limited partner with the National Skill Development Corporation to train underserved youth, directly advancing ESG goals around livelihood generation, gender inclusion, and ethical governance.

India’s formal ESG reporting ecosystem is maturing. SEBI ’s mandatory BRSR framework for the top 1,000 listed companies has set a baseline. It aligns with the nine principles of the National Guidelines on Responsible Business Conduct  and emphasizes double materiality. However, for startups, SMEs, and unlisted firms, the reporting burden can be daunting. Many of them focus on operational KPIs and impact metrics tailored to funders or philanthropic partners rather than standardized ESG disclosures. While a few voluntarily adopt Global Reporting Initiative (GRI) , SASB Standards , or SDG linked disclosures, most operate in a grey area of good intentions without formal frameworks. Further, ESG rating agencies rarely consider localized, qualitative, or grassroots data. This leads to underreporting of positive impact from organizations operating in informal or rural settings. Without government support and simplified tools, much of India’s genuine ESG momentum risks going unnoticed in formal ESG assessments.

Conclusion

Today’s ESG ratings and metrics have helped shine a light on corporate behavior, but the real test lies ahead where it is yet to be seem evidently that they can truly measure and accelerate impact. To meet this challenge, ESG frameworks must become more comprehensive, transparent, and grounded in real world outcomes. This means standardizing methodologies, strengthening data quality, integrating planetary boundaries, and aligning closely with global goals like the SDGs. It also means recognizing the complexity of sustainability acknowledging tradeoffs, local context, and the need for regeneration, not just reduction. The future of ESG will be determined not by who discloses the most data, but by who delivers the greatest change. Ratings, disclosures, and benchmarks must now rise to that occasion. India's ESG landscape is no longer limited to stock exchange giants and CSR departments. A new generation of startups, municipal governments, and social organizations are embedding ESG values into their DNA sometimes organically, sometimes out of necessity. From clean tech innovations and rural water systems to inclusive hiring and transparent governance, ESG uptake in India is both widespread and diverse. However, to unlock the full potential of this momentum, India must move from fragmented adoption to systemic integration. This includes developing ESG tools tailored for startups and NGOs, incentivizing verified impact reporting, and fostering stronger public private collaboration. ESG must be treated not as a compliance burden or marketing tool, but as a national strategy for sustainable development. Only then can India's ESG journey evolve from promise to performance, from compliance to collective impact.

Suggested Solution:

To make ESG ratings truly useful, we need to change how they work. First, they should focus on actual results, not just promises or paperwork. That means measuring things like real emission cuts, clean water access, better working conditions, and how local communities are affected. Second, ESG scores should be standardized and verified, so companies can’t simply tick boxes. Third, the people most affected like workers, villagers, or local residents should have a say in these ratings. And finally, the agencies that give these ratings need to be open about how they calculate scores, so everyone understands what’s behind a number.

While ESG has helped bring attention to sustainability, we need to move from intentions to actions. It’s not enough for companies to just talk about climate change or fairness they need to prove they’re making a real difference. This is especially important in industries like finance and construction, where the decisions made can impact thousands of lives and ecosystems. Future ESG systems should also look at indirect impacts like pollution caused by suppliers, or emissions financed by banks and design industry specific tools that match the unique challenges of each sector.

Some ESG rating systems have started taking small but important steps to reflect real world failures, not just polished reports. For example, they now include controversy analysis, which means checking if a company has been involved in lawsuits, protests, or community conflicts. These red flags give a better picture of how a company behaves on the ground. There's also growing use of social media scans to see how companies are actually perceived by people whether they’re acting responsibly or just talking big. However, these improvements are still very new and not used consistently. This makes it even more urgent to shift ESG tools from being about reputation to being about true performance and accountability.

Some ESG tools are now being linked to the United Nations Sustainable Development Goals (SDGs). These are 17 global goals to improve life for people and the planet. For example, ESG scores might show how well a company is doing on issues like clean energy (SDG 7), gender equality (SDG 5), or reducing emissions (SDG 13). Some investors use these tools to understand if the companies they support are helping achieve these goals. But this link is still basic. Many ESG ratings only tell part of the story. A company might say it reduces waste but ignore its impact on marine life (SDG 14). Or it might promote women in leadership but overlook poor labor conditions in its factories (SDG 8). To fix this, ESG tools need to match specific SDG targets and indicators, and not just use broad, feel good language. Companies should also be checked for both the good and bad things they do. For instance, a solar energy company might be helping clean energy efforts, but if it displaces local communities or damages forests, which should count too. New tools like the SDG Impact Standards and Science Based Targets are helping with this, but we still have a long way to go.

Beyond ESG and the SDGs, there’s another idea called Doughnut Economics. This model says that we should live in a “safe and just space” where no one lives in poverty (the social bottom), and we don’t damage Earth’s natural systems (the environmental ceilings). It’s like living inside a doughnut: not falling short on human needs, and not overshooting nature’s limits. Right now, most ESG ratings don’t think this way. They don’t measure whether a company is using too much water, polluting the air, or harming biodiversity. They also don’t check if a company is being fair, inclusive, or helping communities grow stronger. To really support this model, ESG ratings would need to measure whether companies are staying within climate safe limits, supporting fairness and equity, and helping restore the environment. For example, instead of just saying, “we planted 1,000 trees,” a company would have to show how those trees are helping restore a local ecosystem or reduce flood risk. Cities like Amsterdam are already using Doughnut Economics for urban planning. If businesses and rating agencies also begin using this model, ESG can become more than just a label. It can become a real tool for change helping companies do good, not just look good.

Despite all these challenges, there are bright spots that show ESG frameworks can lead to environmental and social progress when taken seriously. Hindustan Unilever, which improved its supply chain transparency and worker safety after ESG risk assessments highlighted gaps. As a result, they’ve gained customer trust and investor support for being more socially responsible. Globally, brands like Patagonia and IKEA have used ESG and SDG linked frameworks to reduce emissions, protect biodiversity, and support fair wages. Their commitment has created stronger brand loyalty and set higher standards for competitors. These stories show that when ESG is treated as a corrective tool or just a PR exercise, but it helps companies make better choices eventually. With pressure from customers, investors, and the planet itself, more businesses are starting to walk the talk. And that gives us hope: ESG, if evolved thoughtfully, can still become a powerful bridge between business and real world impact.