Industry calls for greater transparency on ESG ratings

From Financial Times:

More transparency around ESG ratings would increase the quality of ratings and services made available to investors, say respondents to a EU consultation, including Germany’s BVI and Eurosif.

Transparency in data sourcing and methodologies is one of the most valuable and necessary elements of ESG ratings, according to responses to the European Commission’s consultation on standards for the sector.

The EC’s consultation is set to create greater insight on the functioning of the market for ESG ratings, given their importance in helping investors assess the ESG qualities of the companies and funds in which they invest. 

In its response to the consultation that closed on 10 June, German asset management trade body BVI said that “full transparency is needed about the rating/scoring methodologies, including a description of the underlying data and data sources used by data providers”.

BVI said its members reported several shortcomings in the data services they use, including a lack of transparency in ESG rating methodologies, particularly regarding procedures for unscheduled adjustments of ratings during the year. They also noted that changes to the applied rating and ranking methodologies are sometimes not made clear, or are not subject to consultation with users.

Providing more information

According to MSCI, ESG rating providers could be required to make certain disclosures to improve transparency around their methods.

The company, which provides its own ESG ratings, suggested disclosures through websites or annual reports on the operations and methodologies used by rating providers. Additionally, they could supply more information on how methodologies were applied to specific ratings. 

Kifaya Belkaaloul, head of regulatory at asset management software provider NeoXam, said there was a “clear lack of transparency” on methodologies, which in turn affected the “quality and availability of the ESG data that is on offer”. High-quality data was essential to uphold ESG investing as a “vital pillar of finance”, Belkaaloul added.

Diana Rose, ESG research director at sustainability data compan Insig AI, noted that good provenance of information and quality of data was critical as a basis on which to make investment decisions. Without this, it would be difficult to “move the needle” on sustainable investment to the degree needed. “Right now, the lack of transparency around ESG ratings is threatening to undermine the integrity of the movement,” Rose said.

Will Chignell, chief commercial officer for ESG at Apex Group, suggested that the explosion in the number of ESG data providers had been a double-edged sword as it had made it “easier than ever” to gather ESG data, but had also “diluted the quality of data collection and subsequent analysis”. 

“Meaningful, measurable, relevant data, independently verified, aligned to the best-in-class standards, is vital to drive impactful change,” he said.

Regulatory intervention

One main driver for the consumption of ESG data has been the introduction of regulatory frameworks such as the Sustainable Finance Disclosure Regulation, which imposes transparency obligations and reporting requirements on investment management firms at both a product and manager level.

The BVI highlighted that such regulatory requirements helped data providers build a dominant market position, in some cases potentially creating an oligopoly (or even a monopoly) position on certain data and analytical approaches. According to the BVI, the EC should “strongly recognise that large sustainability data providers, such as MSCI, Morningstar, ISS, hold disproportionate market power on data generated from company information”.

Consequently, it suggested that sustainability data costs – including data pricing, licensing practices, definitions, audit procedures and connectivity fees – should be subject to regulatory oversight.

Eurosif, the European association for the promotion of sustainable and responsible investment, stated in its response: “The main objective of any regulatory intervention should be to bring more transparency and robustness on the ESG ratings provided to the market, thereby creating stronger market incentives to increase the quality of ratings and services made available to investors.”

NeoXam’s Belkaaloul agreed, adding: “This, in turn, would enable far easier comparisons between the data coming from different providers and help end-users to consolidate the ESG data that they consume.”

However, Volker Lainer, ESG and regulatory lead at specialist data company GoldenSource, argued that regulatory intervention was not entirely necessary. 

“Transparency is needed in ESG investing to avoid erroneous credit decisions stemming from ratings bias and differing ESG rating methodologies,” he said. “The way to achieving this is possible without regulatory intervention but requires market participants to truly understand the well-documented heterogeneous methodologies of the different ESG ratings agencies and data providers, consciously leverage the different rating approaches and assessment technologies, and embrace their diversity to provide themselves with a fuller picture.”

Responses from market participants to the EC’s consultation will feed into an impact assessment that will evaluate whether a possible policy initiative is needed on ESG ratings and on sustainability factors in credit ratings. 

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