LONDON (Reuters) – Environmental, social and governance (ESG) ratings, widely used by asset managers to make climate-friendly investments, need tighter oversight to avoid risks to the smooth functioning of financial markets, Britain’s Financial Conduct Authority said on Tuesday.
Investors are increasingly demanding that asset managers put their cash into companies that meet “green” or ESG criteria, with references to ESG ratings embedded into their investment processes, the FCA said.
But the ESG ratings business, a market that could be worth $1 billion this year, has no firm definition of data provision that applies globally, the FCA said.
ESG ratings providers, which rank companies’ performance based on ESG factors, have different methodology and use different ways to plug gaps in data, leading to little correlation between them, the FCA said.
Combined with other features of ESG rating provision, there may be “potential for harm to market functioning, or to consumers, in some circumstances”, the FCA said in a consultation paper on Tuesday.
“Since ESG rating providers operate and cover companies globally, we consider that there would be a strong benefit in a globally applicable regulatory approach, rather than a local regime,” the FCA said.
“However, global coordination can often take time and the harms may arise locally in the meantime.”
There has been a flurry of consolidation among companies that provide ESG ratings. MSCI has acquired Innovest and KLD, Moody’s has bought Vigeo Eiris, Morningstar taken over Sustainalytics, S&P Global completed an acquisition of RobecoSAM in January 2020 and the London Stock Exchange Group completed its acquisition of Refinitiv this year.
Policy options include guidance for firms on using ESG data and ratings, a best practice code for ESG data and rating providers, and introducing regulation of ESG data and raters, which has already been suggested by regulators in the European Union, the FCA said.
The EU’s securities watchdog has said regulation is needed for raters to avoid “greenwashing”, which refers to giving a misleading impression of green credentials.
(Reporting by Huw Jones. Editing by Jane Merriman)