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ESG data providers to face scrutiny in Japan over research practices

First code of conduct for the ESG data industry will focus on analyst capabilities and resources.

The article has been amended to include a response from proxy voting advisor ISS in response to a critical study on the effectiveness of its recommendations.

ESG data providers may be required to ensure that they have sufficient analyst resources and provide career development opportunities under the world’s first code of conduct for the sector, currently being developed for the Japanese market.

Meeting notes from a panel convened by the Japanese Financial Services Agency (FSA) to advise on the upcoming code reveal draft provisions for ESG data houses to allocate “sufficient human resources to ensure the quality of the evaluation and data provision services they provide, and… develop their own professional skills”.

Capacity building and development of human resources “will ensure the continuation of high-quality evaluations”, the panel said.

The move could increase scrutiny on the staffing practices across the broader ESG data market, following longstanding concerns from users over the quality of internal resources and capabilities at service providers. In a letter to EU regulator ESMA earlier this year, the European Banking Federation claimed that ESG data firms were “understaffed” with respect to the complexity of the evaluations which they undertake. According to the EBF, this meant that analysts were unable to thoroughly assess company-specific risks, resulting in instances of “factually incorrect analyses and misleading/incorrect conclusions”.

The EBF also identified a gap among providers in relation to the banking sector, arguing that “there is a knowledge shortfall in relation to knowledge about law, regulation and basic banking principles”.

Meanwhile, a separate academic study on the effectiveness of ISS proxy voting recommendations from 2020 suggested that the practice of hiring “temporary, and potentially less experienced analysts” was a contributing factor to “lower quality assessments”. The study’s findings was rejected by ISS in an extensive response published by RI.

The FSA’s code is the only regulatory initiative to date to consider human resource management and could influence rule-making in other jurisdictions as a result. Recent scoping exercises by the EU, the UK and global regulatory body IOSCO have not referenced provider staffing practices.

Other topics being considered for inclusion within the FSA code include internal quality and verification checks, managing conflicts of interest, transparency of methodologies, and data collection processes.

The FSA panel is due to convene later this month to discuss and finalise the provisional code, followed by a public consultation. While the code is expected to be applied on a voluntary basis, companies which do not implement its provisions will be asked to explain the omission.