Regulate ESG data providers, advisors tell European Commission

Experts have advised the EU to set up a certification and supervisory regime for ESG data and ratings providers, as well as developing industry standards. 

London-based think tank SustainAbility has made eight recommendations on ESG data and disclosure as part of a 214-page report on the "state of play" for sustainability-related products and services, commissioned by the European Commission last year. 

The firm, which is owned by consultancy ERM, released its findings last week. 

It proposes industry standards covering “the overall objectives of the rating and data provider, appropriate governance structures and codes of conduct, means of engagement with companies, the process for correcting errors and updating assessments, the transparency of methodologies, the consideration of materiality and risk of bias”. 

Growing demand for sustainability-related products has led to a flurry of market entrants and an “uptick in merger and acquisition activity”, SustainAbility notes, as “traditional financial services and research firms seek to expand their service offerings by buying up specialised sustainability-related product and service providers”. But the think tank also highlights that such products “are not regulated by public authorities” at present.

Companies also expressed concerns around a lack of “direct engagement” by ESG providers, with some highlighting instances of providers “not correcting data errors”

Concern about the lack of regulation around ESG data providers and their products has been growing among financial regulators in Europe. Last month, France’s Autorité des Marchés Financiers and the Dutch Autoriteit Financiële Markten – two of Europe’s most powerful national securities regulators – put forward proposals for mandatory regulation of all ESG data providers by the European Securities Market Authority (ESMA).

Months earlier, ESMA itself, along with Europe’s two other financial regulators, the European Banking Authority and the European Insurance and Occupational Pensions Authority, reiterated calls for “minimum standards” around ESG ratings and EU level supervision of ratings providers in response the Commission’s consultation on the Renewed Sustainable Finance Strategy, the sequel to Action Plan, which is expected to be published in March. 

SustainAbility’s study involved surveying the market to gauge views on ESG data providers. Only 19% of the companies surveyed said they regard current ESG ratings and research as an accurate reflection of their “sustainability exposures and management practices”.

Companies also expressed concerns around a lack of “direct engagement” by ESG providers, with some highlighting instances of providers “not correcting data errors”. 

“[L]ack of engagement may help a company get a better score if it knows how to work the rating system, or it may hurt companies that are not engaged appropriately. Either way, it brings into question the accuracy of ESG ratings,” SustainAbility warns. 

One of the key issues flagged by investors and benchmark providers was the lack of transparency on the underlying methodologies used by ESG data providers.

SustainAbility warns that this lack of transparency could lead to a “lack of understanding as to what the rating represents and presents a risk that investors will take sustainability-related ratings at face value, without making their own judgements and considering whether and how well a rating helps the investor meet their sustainability investment objectives.”

Andy Howard, Global Head of Sustainable Investment at Schroders told RI that the “report highlights a number of points we have made for some time”. He added that: “We would expect most rating firms to have robust processes in place, transparency is vital for investors to use those measures effectively and to understand the range of analyses available.” 

SustainAbility’s recommendations in full

1. The disclosure of sustainability-related rating methodologies, including key factors such as the specific assessment criteria, sources of data, rationale for weighting, and any standards or guidelines considered.

2. The development and application of industry standards for sustainability-related rating and data products providers, including the establishment of a certification system and the appointment of an appropriate supervisory body. 

3. The communication of sustainability-related ratings, data and research with target companies, including requiring that this is shared free of charge and restricting communication of outputs ahead of publication.

4. Require sustainability-related rating, data and research providers to issue a purpose and limitation statement for published sustainability-related rating, data and research to users, in order to provide clarity on the objectives of the product and any limitations that are considered to apply.

5. Seek to ensure public disclosure of the management of conflicts of interest by sustainability-related rating data and research providers. 

6. Require disclosure in the form sustainability-related declarations by asset managers in relation to the application of sustainability factors in investment management practices, the integration of sustainability factors into the investment analysis of companies they own, a report on sustainability engagement action undertaken and the percentages of research spent on sustainability investment research.

7. Take action to enhance company sustainability disclosures with the aim of improving the comparability, completeness, consistency and quality of data disclosure.

8. Provide clarity of terminology and support capacity building on sustainable finance and sustainability-related products and services for all market participants and stakeholders to address the need for greater consistency in key terms used and definitions applied, and improved awareness of sustainability-related products and services across market actors.