The need to shift global investment towards sustainable activities and inform decision-making continues to amplify the momentum for ESG ratings and data product providers. A report from ERM indicates that in 2022, 94% of investors used ESG ratings and data products at least once a month. Providers aiming to fulfil this growing demand have launched multiple innovative products to address investor needs. By 2020, SustainServ identified over 40 ESG ratings, 150 ESG rankings and 450 ESG indices.
As the role of these tools grows, scrutiny by regulators increases. Policymakers are studying this emerging policy area to understand the market, as well as the need for regulatory intervention. While findings from public consultations and other exercises have led policymakers to identify similar shortcomings associated with ESG ratings and data products, jurisdictions are taking different approaches to address them.
IOSCO’s work: a milestone in the policy debate
After launching a public consultation, the International Organization of Securities Commissions (IOSCO) published in November 2021 a report with recommendations on the provision, use, and potential regulation of ESG ratings and data products. The report provided an overview of the market and categorized different products primarily into “ESG ratings”, “ESG data products”, and “other ESG products and services”. It also identified shortcomings associated with the provision of ESG ratings, mostly associated with management and prevention of conflicts of interest, transparency, governance, and systems and control. Based on these shortcomings, IOSCO outlined 10 recommendations for improving the provision and use of ESG ratings and data products.
Figure 1 – Main topics associated to IOSCO’s recommendations
IOSCO’s first recommendation called on regulators to “consider focusing more attention on the use of ESG ratings and data products and ESG ratings and data products providers that may be subject to their jurisdiction.”[1] Of the detailed procedures set out for this recommendation, two have inspired market and supervisory authorities to engage: developing voluntary codes of conduct and pursuing regulatory oversight. IOSCO’s work has served as a milestone for regulators, and has inspired jurisdictions, primarily in Europe and in the Asia-Pacific (APAC) region, to engage.
Figure 2 – Map of jurisdictions engaging in the emerging policy area of ESG ratings and data products
APAC: Japan, Singapore, and India
In December 2022, the Japanese Financial Services Agency (JFSA) published its voluntary and principles-based Code of Conduct for ESG Evaluation and Data Providers. Inspired by IOSCO’s recommendations, the scope includes both ratings and data providers that participate or provide services to participants of the Japanese financial market. The Code recognizes that “there are currently no specific regulatory regulations for the businesses of, or statutory definitions for, ESG evaluation and data providers,”[2] and therefore instead of outlining definitions for multiple ESG products, the Code introduces a broader approach of “basic concepts” and “services”. Following its publication, the JFSA is seeking the endorsement of ESG ratings and data providers.
In Singapore, a draft code of conduct is expected to be published for consultation by the Monetary Authority of Singapore (MAS) in the second quarter of 2023. MAS recently announced its work with the industry and specified that providers will be required to explain how they factor transition risks into their products.
Unlike the normative approach adopted by Japan and Singapore, the Securities and Exchange Board of India (SEBI) is expected to introduce prescriptive measures. In March, the Board announced the approval of a regulatory framework for ESG ratings providers which would introduce a new chapter in SEBI’s Credit Rating Agencies Regulations from 1999. The amendments are expected to focus on transparency and mitigation of conflict of interest - themes similar to those from IOSCO’s recommendations. In addition, the amendments will also focus on facilitating ESG ratings based on assured data and transition finance in India.
Europe and the United Kingdom
In the United Kingdom, both normative and prescriptive approaches are being developed. In November 2022, the Financial Conduct Authority (UK FCA) announced the formation of a working group to develop a voluntary code of conduct. In addition, HM Treasury has launched a public consultation to assess the future regulatory regime foreseen for ESG ratings. HM Treasury indicates transparency of methodologies, governance, and processes of ESG ratings providers as outcomes to be potentially introduced through regulation. Like other jurisdictions, these topics converge to those recommended by IOSCO.
However, unlike IOSCO’s definitions, HM Treasury defines ESG ratings more broadly as “an assessment regarding one or more ESG factors, whether or not labelled as such.”[3] In addition, it also dedicates a significant portion of the consultation towards defining the scope of regulation. While the outcome is yet to be seen, this scoping exercise suggests that the upcoming UK regulation may vary (at least in scope) from other regulatory initiatives.
In Europe, more stringent regulation is also expected, following the results published by European Securities and Markets Authority’s (ESMA) of its Call for Evidence on ESG ratings. While the proposal has not been published yet, the topic “regulation on ESG ratings” has already been scheduled for oral procedure in the European Commission agenda.
Opportunities and limitations for future policymaking
Whether through codes of conduct or regulation, policymakers have thus far focused their interventions on the transparency of methodologies rather than on methods per se. Protecting the diversity of assessments is important, as different products may support different aspects of the transition to a net-zero, nature positive economy.
Clearly, there are currently differences in approach (normative vs. prescriptive), scope (ESG ratings only vs. ESG ratings and data products), and in definitions of ESG ratings and data products. While the first two may be intrinsic to policymaking, the latter requires careful consideration. ESG ratings and data products are offered and used globally, therefore, their definitions should also agree on a global level. Policymakers and providers of ESG ratings and data products must work together towards converging these definitions.
As this emerging policy area develops, monitoring the outcomes and constantly engaging with relevant stakeholders is crucial to ensure the effectiveness of each intervention. In March, CDP hosted Roundtable, in partnership with the Future of Sustainable Data Alliance (FoSDA) to promote a constructive discussion among providers, regulators, and investors. A reflection on this dialogue, as well as potential ways forward, have been previously shared through this blog post. In a few months, CDP will publish a report on this topic with key findings and recommendations associated with the provision and regulation of ESG ratings and data products.