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Esma highlights ESG data and ratings shortcomings

By Rob Langston

Low levels of transparency on methodologies and lack of coverage top industry respondents’ complaints about ESG data and ratings.

Europe’s securities markets regulator has identified a lack of industry and company coverage and low transparency of methodologies applied by environmental, social and governance ratings and providers, following a call for evidence.

In a letter to John Berrigan, director-general for financial stability, financial services and the capital markets union at the European Commission, the European Securities and Markets Authority highlighted the shortcomings of ESG data and ratings in the EU as identified by its 154 responses.

Respondents highlighted the lack of coverage of industry and entity types, as well as the insufficient granularity of data – which was a particular issue for small and medium-sized enterprises and non-listed companies.

Other shortcomings included low levels of transparency for rating methodologies and data sources, hampering the reliability of ratings and comparability with other providers.

A lack of standardisation, low correlations between different providers’ ESG ratings, and misalignment on the definition of ESG were also major challenges.

Esma chair Verena Ross said the feedback from respondents on ESG rating and data providers was indicative of “an immature but growing market”, which, after a number of years of consolidation, has seen the emergence of a small number of large providers headquartered outside of the EU, similarly to the structure of the credit ratings market.

The Esma chair added that the evidence could prove helpful for an assessment of the need to introduce regulatory safeguards for ESG rating products.

Understanding limitations

The issues highlighted by respondents are why Nazmeera Moola, Ninety One Asset Management’s chief sustainability officer, puts “limited reliance” on ESG ratings.

She said: “We prefer instead to rely on the judgment and analysis of our investment teams as the main input to understanding and assessing ESG and sustainability factors in our investment processes.

“We do make use of ESG ratings to flag potential risks however, which the ESG risk team monitor and discuss with the relevant investment team to understand if these signal real concerns.”

Kate Elliot, head of ethical, sustainable and impact research at Rathbone Greenbank Investments, said her company had recognised the weakness of relying on a single data source for ESG and the dangers of relying on an external provider for opinions.

While Rathbone Greenbank Investments does use some third-party ESG data and ratings, it supplements this information with other sources.

“This enables us to build a holistic view of an organisation while filtering out potential biases in methodology or source,” Elliot said. “It also allows us to fill in gaps in reporting or coverage so we are, as far as possible, judging companies on their sustainability performance rather than the strength of their disclosures.”

She added: “It is vital that investors understand the inputs and methodologies of any ratings they rely on. Providers that are unable or unwilling to provide information on their methodology would be viewed less favourably than those who are transparent in their approach.”

Data standards improving

Neil Brown, head of equities at GIB Asset Management, said ESG data was continuing to evolve and that issues around collection and disclosure are present throughout company reporting.

“Our focus is on the data itself and the ability to compare it readily against peers, and transparency in this area is often sufficient in our view,” he explained.

“If we believe important data is missing from company disclosure our preference would be to work with them through constructive engagement to make the case for improved disclosure.”

Alex Rowe, lead portfolio manager of the Nomura Global Sustainable Equity Fund, said there were other shortcomings of the data behind ESG scores that need to be addressed, such as core impacts of companies.

“In certain cases, we have seen companies that are having very positive impact on social or environment challenges through their products and services, which have poor ESG ‘scores’ as a result of not having certain policies in place, or making certain disclosures,” Rowe said.

Esma said it would continue to support the commission in its work on regulations around ESG ratings providers.

A service from the Financial Times