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IOSCO to tame wild-west world of ESG ratings

24 Aug 2021

Global body wants to improve accuracy in sustainability analysis, reports Andrew Holt.

A body representing global financial regulators wants to boost confidence in the unsatisfactory world of corporate environmental, social and governance (ESG) ratings by creating some form of official oversight of ESG investment funds.

Raters of ESG-related products and data providers are largely unregulated, which the International Organization of Securities Commissions (IOSCO) has criticized in a new consultation paper.

The global association for market and securities regulators in the US, Europe and Asia says this has led to a ESG rating situation that lacks transparency in the overall approaches used, creating a situation that results in uneven coverage and can lead to potential conflicts of interest.

“IOSCO has observed 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,” the paper stated.

Ashley Alder, who chairs IOSCO and heads Hong Kong’s securities watchdog, noted: “Users have signaled that having multiple ESG ratings and data products can cause confusion, raising serious questions about relevance, reliability and greenwashing.”

Asset managers running ESG-related funds use about 160 raters globally to help pick stocks and bonds, IOSCO noted. Asset owners generally do not, or cannot realistically, undertake any verification of the ratings.

IOSCO’s consultation paper, therefore, recommends that regulators consider regulating the sector. Regulators could then encourage the industry to develop and follow codes of conduct. “ESG ratings and data product providers could consider making high levels of public disclosure and transparency an objective in their ESG ratings and data products, including their methodologies and processes,” read the paper. “ESG raters could maintain internal records to back up their ratings and give assurance the scores are ‘free from political or economic pressures’,” it added.

Moreover, raters should ensure there is no conflict of interest between selling ratings on companies they may also have a business relationship with, IOSCO warned.

“This market currently does not fall within the typical remit of securities regulators, hence leading IOSCO to propose key considerations for securities regulators in this area,” noted the paper.

Erik Thedéen, chair of the IOSCO Sustainable Finance Task Force, and director general of Finansinspektionen of Sweden, added: “We have sought to understand all facets of the challenges and risks that may arise with regards to the use of ESG ratings and data products. This complements our efforts on addressing the lack of reliability and comparability of data at the corporate level and the recommendations we have set out for asset management activities in the field of sustainability.”

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