NEWS & VIEWS
ESG is a growing theme across major industries, and the financial sector is not exempt. To date, ESG regulation has mainly focused on investment and asset managers.
Global governing bodies are continuously increasing the Environmental, Social and Governance (ESG) responsibilities of asset managers, in a bid to promote sustainable investment. The UNEP’s Fiduciary Duty in the 21st Century report found that “500 policy instruments…support, encourage or require investors to consider long-term value drivers, including ESG issues”.
Amongst these are the new MiFID II regulations, which require asset managers to take into account the sustainability preferences of their clients. Similarly, the UK’s ‘Green Finance Roadmap’ aims to reconcile ESG with investing, requiring asset managers to “disclose how they are managing their sustainability risks…and how they take sustainability into account in managing or administering investments on behalf of clients and consumers.”
Data providers aim to ease the process for asset managers, providing ESG ratings for companies by looking at their carbon emissions, supply chain labour standards and business ethics, amongst many other factors.
While these steps are welcome in advancing ESG missions, there is no standardised way to measure ESG – as such, ratings between data providers can differ for the same company. MIT paper ‘Aggregate Confusion: The Divergence of ESG Ratings’ discovered that “the correlation among six prominent [ESG] ratings agencies was on average 0.61. In comparison, mainstream credit ratings from Moody’s and Standard and Poor’s are correlated at 0.99.”
The Organisation for Economic Co-Operation and Development (OECD) acknowledge these challenges in their 2020 ‘ESG Investing: Practices, Progress and Challenges’ report, and recommend a two-pronged regulatory approach: firstly, a standardisation of ESG disclosures to ensure quality data and, secondly, ensuring that the key metrics chosen for ratings are based on “financial materiality”.
The financial industry is likewise expressing this need to regulate ESG data providers to ensure accuracy. A majority of delegates at Environmental Finance’s ‘The Future of ESG Data’ Conference in October believed that rating providers will be regulated within the next three years, with Reinhilde Weidacher, Global Head of ESG data strategy at ISS ESG, echoing their sentiments.
EFAMA (The European Fund and Asset Management Association) has also called for the European Commission to regulate data providers in a bid to ensure ESG data is accurate and reliable. Regulation in this area would be an extension of the MiFiD regulations in seeking to protect and educate consumers so that they are able to make informed investment decisions.
The UK’s FCA (Financial Conduct Authority) recently proposed new sustainable fund labels to combat ‘greenwashing’, as part of its new Sustainability Disclosure Requirements Consultation Paper. The three labels aim to cover the range of assets at different stages in their journeys towards sustainability:
- Sustainable Focus: “Products with an objective to maintain a high standard of sustainability in the profile of assets by investing to (i) meet a credible standard of environmental and/or social sustainability; or (ii) align with a specified environmental and/ or social sustainability theme.”
- Sustainable Improvers: “Products with an objective to deliver measurable improvements in the sustainability profile of assets over time…invested in assets that, while not currently environmentally or socially sustainable, are selected for their potential to become more environmentally and/or socially sustainable over time, including in response to the stewardship influence of the firm.”
- Sustainable Impact: “Products with an explicit objective to achieve a positive, measurable contribution to sustainable outcomes…invested in assets that provide solutions to environmental or social problems, often in underserved markets or to address observed market failures.”
These labels mark a significant step forward in the FCA’s plans to make ESG a priority and with possible implementation as soon as June 2024, spur rating providers to employ ESG strategies that align with the guidance.
Governments and conduct bodies are thus making strides to ensure that legislation assists ESG appropriately and in turn allows investors to realise their sustainability goals. We await the EU’s response and look forward to the enhancements ESG will make to the industry.