The reliability of ESG data products is hampered by low levels of transparency, patchy coverage and poor responsiveness, according to users based in the EU.
The findings are based on a survey of the ESG data sector – including users, providers and rated entities – by EU securities watchdog ESMA, which concluded in March. This will feed into another market scoping exercise, this time conducted by the European Commission, on the possible need to regulate the sector.
According to ESMA, the most common complaints among users related to low levels of transparency of methodologies and data sources, as well as low correlation between ESG ratings.
Respondents also identified a lack of coverage on certain industry sectors, such as SMEs, due to the poor availability of public data for smaller entities. A purported “US bias” was also noted, resulting in products which are “consistently biased towards larger and/ or listed companies, as well as US industries, while EU companies… are penalised”.
In addition, users claimed that providers often “lacked an adequate number of skilled resources to ensure timely follow-up on their portfolios”.
Separately, companies which are rated by ESG data houses said providers were slow to update ESG ratings and correct errors in the products. Some noted that there were providers which offered a paid service to identify and communicate errors.
Pricing trends also emerged as a key issue, according to ESMA, with users blaming recent price increases on a wave of consolidation within the sector, which has seen smaller providers snapped up by data giants such as MSCI, Morningstar, Moody’s and LSEG. The trend has led to a rise in conflicts of interest risks, said users.
ESMA has independently flagged some of the issues in recent years, most notably in its biannual market risk report last year, which described the market for ESG ratings as “fertile ground for potential conflicts of interest”. Oligopolies created by “large companies buying their way into the market” could “lead to significant consumer detriment, including pricing above competitive levels, risk of collusion, entry carriers, and reduced innovation and efficiency”, ESMA said at the time.
Regulatory initiatives put forward by the European Commission have so far focused on improving product transparency and disclosure of conflicts of interests. The Commission has distanced itself from standardising methodologies to improve the correlation of competing ESG ratings.
While staffing practices across the sector have received little attention from EU and global regulators to date, the issue is expected to be addressed by a first-of-its-kind code of conduct for ESG data providers being developed by the Japanese Financial Services Authority.
Responsible Investor asked ESMA for additional details regarding the market feedback but had not received a response at press time.
On a sector-wide basis, ESMA found that the bulk of revenues were generated by a small number of dominant providers. Respondents most frequently mentioned MSCI as a supplier of ESG ratings, followed by Morningstar, ISS, S&P and Moody’s, out of a total of 59 providers active within the EU.