The International Organisation of Securities Commissions (IOSCO) has published a consultation paper aimed at mitigating risks emanating from the activities of environment, social and governance (ESG) ratings and data providers.
In the paper, IOSCO, which sets standards for securities market regulators across 130 jurisdictions, recommends that watchdogs consider formally regulating the sector, in s similar way to credit rating agencies in the aftermath of the global financial crisis over a decade ago when similar concerns were raised.
The IOSCO paper proposes regulatory considerations covering the providers’ conflicts of interest issues, transparency of their methodologies and information sources, as well as their policies and procedures followed.
The umbrella organisation said it found a lack of transparency about the methodologies underpinning ratings or data products, and “an often uneven coverage of products offered across industries and geographical areas”.
It said, “that this could lead to gaps and inconsistencies when applied to investment strategies and raise concerns around the management of potential conflicts of interest, such as fee structures and insufficient separation of business lines that provide advisory services to issuers to improve their ratings performance.”
It advised users to identify the sources of information used by third-party vendors to build ESG products and to ensure that the information is up to date.
In addition, IOSCO said, they should also look at whether “any gaps in information are filled using estimates, and if so, the methods used for arriving at these estimates”.
ESG data, service and ratings providers play an increasingly important role as investor demand for ESG integration in the investment process grows.
Recent figures from Bloomberg Intelligence predicts that global ESG assets are on track to exceed $53 trn by 2025, representing more than a third of the $140.5 trn in projected total assets under management
Asset managers running ESG focused funds are estimated to rely on around 160 raters globally to help pick stocks and bonds.
“The use of ESG rating and data products is on the rise but most jurisdictions do not have regulatory frameworks which explicitly cover the providers of these products,” said Ashley Alder, IOSCO Chair and Chief Executive Officer of the Securities and Futures Commission of Hong Kong.
He added, “Users have signalled that having multiple ESG ratings and data products can cause confusion, raising serious questions about relevance, reliability and greenwashing. The recommendations made in this report are part of our efforts to address the challenges and risks faced by ESG ratings and data providers as well as by the users of these ratings and data products and the companies which are subject to them.”
The pressure on third-party vendors is especially rising in Europe, as asset managers are expected to comply with the European Commission’s Sustainable Finance Disclosure Regulation (SFDR).
SFDR requires asset managers and other financial service providers to both categorise their ESG-labelled products and to evidence their reasoning when Level 2 comes into force next year.
Justifications for these categorisations will partly be informed by third-party ESG-related scores and ratings of individual holdings within each fund.
The consultation is the latest piece to the overall sustainability framework that IOSCO is developing. The ‘Report on Sustainability-related Issuer Disclosures’, which addresses data gaps at the corporate level, and the ‘Recommendations on Sustainability-related Practices, Policies, Procedures and Disclosure in Asset Management’, which emphasises the important role asset managers play in the deployment of investor capital into sustainable finance, were both issued in June.
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