Pietro Bertazzi embraces the potential for increased scrutiny of ESG ratings and data products to harness data for public good, but warns of the risk of potential regulatory fragmentation undermining its aims.
Despite some concerted narratives suggesting otherwise, ESG remains rapidly on the rise. Capital raised for private markets ESG funds tripled between 2020 and 2022 - from $29bn to $92bn. It’s estimated that global ESG-related assets under management will increase by 84% to reach $33.9 trillion by 2026.
In tandem, ESG ratings and data products have proliferated in response to investors’ increased demand for ESG data and its assessment. Recent analysis suggests that 94% of investors use ESG ratings and data products at least once a month.
As the role of these tools continues to grow, scrutiny from regulators is increasing, rightly aiming to kick greenwashing to the curb and ensure that ratings and data products truly serve as a guide for capital allocation. To most, the speed at which this has shot up the global policy agenda has been astounding: over the last 12 months some of the largest economies have signaled their intention to legislate – and legislate quickly. Since December of last year, regulators in Japan, the UK, EU, Singapore and India have progressed towards policy interventions.
Naturally, public debate has heightened. Pundits, politicians and asset managers alike continue to debate: do we need standards for ESG ratings? How – if at all - should we regulate ESG ratings? Should we separate the provision of ratings by ‘E’, ‘S’ and ’G’?
However, we are failing to ask ourselves the most fundamental question. The blinders worn by most key players pose massive risks to the global economy. There is no doubt the regulation of ESG ratings and data products is coming. The question we must be asking is: “How can we ensure this regulation is impactful and ensures data is truly used for public good?”.
As the global environmental disclosure system, CDP has been exploring this question over our 20-year history. Just last month – at a crucial time when regulators were beginning to publish and consult on their proposals - we released the first extensive examination of what is, worryingly, a far too fragmented policy landscape. ESG ratings are already being defined differently by regulators in the UK, EU, India and Japan, suggesting that regulation may be stricter or broader in some regions.
The nuances observed across jurisdictions pose significant challenges to regulators as well as all market players, as ‘ESG ratings’ may come to mean different things in different geographies. This regulatory divergence would lead to market chaos, increase compliance complexities for providers and users of these services that operate globally across jurisdictions, and create a significant fragmentation in the regulatory architecture of ESG ratings and data products. In turn it could stop policymakers from achieving their core objectives: regulating the functioning of the market, increasing transparency and trust, ensuring ESG-related tools are used for public good and deterring greenwashing schemes.
Furthermore, regulators are currently defining the territorial scope of their policies differently. If regulators disagree on the territorial scope of their interventions, market confusion and compliance complexities will pose a challenge for both users and providers of ESG ratings and data products. More troubling, however, is if these regulations contradict one another. This would leave both providers and users in a close-to-impossible situation – they cannot be two things at once.
Conflicts of interest are, rightly, part of regulators’ proposals. However, in the current environment, approaches towards management of conflicts of interest also diverge. Japan closely followed IOSCO global guidelines and focused on developing policies to prevent and mitigate conflicts, as well as on disclosing potential conflicts. Europe and India, however, have opted for a more rigorous approach by requiring separation of businesses and activities from ESG ratings providers.
One can see, therefore, that this fragmentation permeates key considerations of the emerging policies. If regulators do not agree on what providers need to disclose about their methodologies and operations, policy initiatives will fail to promote transparency and good governance. It clearly risks undermining the core objective of upcoming regulation: ensuring ESG ratings and products are used for public good. This is a fast-evolving area, which means that regulators have no time to lose in righting the current wrongs and misalignments.
To avoid fragmentation in the regulatory architecture of ESG ratings and data products, as well as to ensure fine compliance from providers and users operating globally, regulators must pursue a common baseline to define ESG ratings and data products. Regulatory frameworks should adopt similar approaches towards their territorial scope to avoid market confusion and contradiction across policy initiatives.
Regulators must be more specific on what type and level of information providers need to disclose. IOSCO has outlined a procedure that policymakers would do well to follow, supporting them to agree a common baseline and minimum requirement for disclosure. Similarly, it provides guidance which can be adopted as the baseline for requirements on management of conflict of interest. This vital work has been done by IOSCO so regulators can hit the ground running.
Following these steps is essential. Those of us working on environmental disclosure for decades know all too well what happens with a lack of coordination, collaboration and standardization. Let us learn from those failings. The current consultations run by national authorities facilitate the dialogue which we trust will inform decision making. ESG ratings will be regulated, and we now have the chance to do it well.