Japan releases world’s first code of conduct for ESG data providers  

    Voluntary code advises investors to pay attention to objectives and limitations of ESG data.    

    Japan’s FSA: ‘monitor your managers’

    ESG data providers operating in Japan will be asked to ensure they have sufficient numbers of qualified analysts and give companies time to examine information for errors under a draft code of conduct published by the country’s Financial Services Agency (FSA) yesterday. 

    The code is the first of its kind to be issued by a national regulator and follows calls from the International Organisation of Securities Commissions (IOSCO) last year for tighter policing of data providers amid mounting concerns over a lack of transparency and potential conflicts of interest. 

    In its current version, the code will require data providers to “secure necessary professional human resources” and “develop capacity building of human resource… even if individual employees do not necessarily have all the necessary expertise”. The ESG market is currently facing a shortage of skilled human resources, the code noted. 

    The move could increase scrutiny of staffing practices across the broader ESG data and services market, following long-held fears over the quality and depth of internal resources at providers. A 2020 study by MSCI concluded that ESG scores now impact companies’ cost of capital, but the European Banking Federation claimed earlier this year that data firms were “understaffed”, resulting in instances of “factually incorrect analyses and misleading/incorrect conclusions”. 

    The EBF also identified “a knowledge shortfall in relation to knowledge about law, regulation and basic banking principles”. 

    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 were rejected by ISS in a response published by Responsible Investor. 

    Providers in Japan will also be asked to provide companies that are the subject of ESG ratings or other data products with their information sources – “thereby allowing time for the company to check whether there are any significant deficiencies”. 

    The code’s remaining provisions require providers to ensure quality control processes are in place, such as checks for discrepancies between stated methodologies and products, and addressing conflicts of interest. Providers must also be transparent about their methodologies and data sources, in addition to making it easier for evaluated companies to raise enquiries about their products. 

    Finally, an appendix to the code includes expectations that investors will carefully examine the objectives and limitations of ESG data products before applying them to investment decisions, and that companies will disclose ESG information in an “easy-to-understand manner” subject to regulatory requirements. While investors and companies aren’t required to apply the code, the expectations are to “encourage market participants… to engage in dialogue with each other”. 

    The FSA has made some notable revisions to the code from an earlier draft that had been proposed by an advisory panel. The initial plans would have required data providers to turn over both their data sources and the corresponding ESG products to companies for checks prior to publication. It also encouraged providers to rely on “public information as much as possible and other sources… as necessary” to ensure product quality. Those requirements have been removed.  

    The code is to be enforced on a voluntary basis with data providers able to opt-in “via public announcement” and by notifying the FSA. Even if they have signed on, the FSA said, providers can adopt a comply-or-explain approach to the rules.  

    It can be applied to all available ESG data and ratings products, including evaluation of ESG bonds and loans such as second-party opinions and certifications. In contrast, a recent consultation by the European Securities and Markets Authority on regulating the sector revealed that stakeholders were divided about whether to regulate ESG ratings specifically or all ESG data products.   

    “The scope of the ESG data market is global in nature, which is why we made sure to incorporate the views of global providers when drafting the code. It is thought that it can be easily adopted by other markets should they wish to consider a similar approach as a starting point,” said sustainability consultant Arisa Kishigami, a member of the FSA advisory panel that had developed the code. 

    The draft code is open for public feedback until early September.