January 3, 2022

Monday Morning Memo: IOSCO Delivered Another Part to Solve the ESG Transparency and Regulation Puzzle

by Detlef Glow.

After the launch of the International Sustainability Standards Board (ISSB) at the United Nations (UN) Climate Summit (COP26) in Glasgow, the International Organization of Securities Commissions (IOSCO) reached another goal by publishing its “Environmental, Social and Governance (ESG) Ratings and Data Products Providers” report. This report contains recommendations for regulators, ESG data and rating providers, and the users of ESG data and ratings.

This report is appreciated by participants from all parts of the investment industry, as the recommendations section starts with a proposal that regulators could consider focusing greater attention on the use of ESG ratings and data products and the activities of ESG rating and data products providers in their jurisdictions. Especially the latter is a topic which has been raised several times by fund promoters around the globe as they witnessed inconsistencies of the evaluation of companies and the underlying data between the different data and rating providers, which is confusing for fund managers and investors. As a result, fund promoters demanded higher transparency on the data and methodologies used for the evaluation of companies. This is because they often only got the results (rating/score) but not the underlying data.

Market observers and participants see this report as a first step to bring a largely unregulated sector under the supervision of securities regulators. Such a regulatory framework is seen as a crucial part of the legislative toolkit to boost the acceptance and success of other sustainable finance initiatives because it has the power to enhance the transparency of ESG data and ratings and may align the activity of the providers of ESG data and ratings with other regulations such as the upcoming EU taxonomy and the Sustainable Finance Disclosure Regulation (SFDR).

In more detail, the recommendations from IOSCO addressed to ESG ratings and data products providers set out that it might consider a number of factors related to issuing high quality ratings and data products. These factors include publicly disclosed data sources, defined methodologies, management of conflicts of interest, high levels of transparency, and handling confidential information.

That said, the IOSCO recommendations not only target the providers of ESG ratings and data products. They are also taking the users into consideration and advocating that users may consider conducting due diligence on the ESG ratings and data products that they use within their internal processes.

The recommendations close with suggestions that ESG ratings and data products providers, as well as entities subject to assessment by ESG ratings and data products providers, could consider improving their information gathering processes, disclosures, and communications between providers and entities subject to assessment.

From my point of view, all initiatives that will help to build unified global standards in the ESG segment and raise the transparency for users of ESG data and ratings should be welcomed by all parts of the financial industry. Especially investors will take profit from these initiatives, as they will experience much higher transparency standards which will enable them to make educated decisions. In addition, higher levels of transparency may help to avoid greenwashing and build trust between investors and fund promoters.

The views expressed are the views of the author, not necessarily those of Lipper or Refinitiv.

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