Providers of sustainability-related services such as ESG ratings must be placed under the supervision of European Securities and Markets Authority (ESMA) in order to enforce transparency on the underlying methodologies used by these providers and avoid conflicts of interest...,
The pair want the European Commission, which already ordered a study
on sustainability ratings and research in 2018, to draft a regulation to
this effect.
There is a strong need among investors and asset managers for “more
reliable ESG data to support the shift towards greener economies,” AFM
and AMF noted in their paper.
According to a recent study by Refinitiv, 98% of global institutional
investors take ESG and sustainability data into consideration when
deciding to invest in a company, yet nearly 83% indeed cite a lack of
reliable data as an obstacle to effective assessment.
Lack of transparency
The two regulators want the proposed regulation to focus on the “lack
of transparency” of the underlying methodologies ESG rating agencies
use to compose their ratings.
They noted the varying definition of ESG performance used by the
different providers, which results in companies receiving very different
ESG ratings depending on the provider, with the exact reasons for this
rating divergence often being unclear.
“Indeed, research shows that the correlation between ESG ratings of
different providers is quite low, especially when compared to the near
100% correlation of credit ratings,” the pair say.
They also said that ESG rating providers’ “constant reassessments of
what ESG performance is” leads to frequent modifications of ESG ratings,
which can have major implications for financial institutions.
Sustainalytics, for example, changed its rating methodology last year, resulting in significant changes in company ratings.
Greenwashing risk
The divergence in ratings between different providers makes it
difficult to correctly appreciate what the ratings reflect, the
regulatory duo noted. They believe this could “lead to misallocation of
investments or even greenwashing.”
Furthermore, the regulatory duo said ESG rating agencies such as
Sustainalytics, MSCI and ISS can also assume different roles such as
consultant, data provider or rating agency, and represent diverse
interests from issuers’ to investors’.
“It is therefore important that potential conflicts of interest are
managed and averted, ensuring an appropriate level of market
transparency.”
Andy Pettit, Morningstar’s director of policy research, EMEA, said in
response to questions from IPE that the company, which owns ESG data
provider Sustainalytics, supports “calls for more transparency with
respect to what ESG ratings providers measure and how providers evaluate
companies.”
No harmonisation
However, he appears worried that European regulators
aim to eventually prescribe definitions of what criteria ESG rating
providers should use in their assessments, despite assurances by the
AMF/AFM that any new regulation should not interfere with the
methodologies used by the rating providers.
“We strongly oppose any attempts by the European Commission to
regulate the harmonisation of providers’ ESG ratings and scores.
Creating a one-size-fits all scenario runs counter to ensuring vibrant
and innovative markets,” Petit added.
While AMF and AFM propose an initial focus on transparency of
methodologies, they are advocating a “step by step approach”, whereby
the initial regulatory framework “should be periodically reviewed taking
into account market developments and, where appropriate, complemented
by additional measures.”
IPE
© IPE International Publishers Ltd.
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