International non-profit organisation CDP has warned of a potential fragmentation of regulatory frameworks relating to ESG ratings worldwide.
Policy initiatives have proliferated in recent years with the aim to regulate ESG ratings, one of the latest being the European Commission´s proposals to tighten the grip on rating providers.
“Jurisdictions that have been engaging with this topic, either by consulting or already publishing proposals for regulations, are diverging in the scope of their interventions and in how they define ESG ratings,” said Pietro Bertazzi, global director for policy engagement and external affairs, in CDP’s latest report – Data for public good: Steering the role of ESG ratings and data product providers.
For example, Bertazzi added, the definition of ‘ESG ratings’ proposed by HM Treasury in the UK has received the attention of market players because it was broader of those put forward by other regulators, and also for remarkably diverging significantly from the one recommended by the International Organization of Securities Commissions (IOSCO) in its report, and considered the global baseline.
Regulatory fragmentation hinders cross border activities, according to CDP, creating confusion among market players.
“We have been advocating for a global alignment of regulatory frameworks, in which regulators can collaborate with one another, build on IOSCO’s recommendations, and implement robust and ambitious policies in this space,” Bertazzi said.
According to CDP’s report, ESG ratings shortcomings are linked to a lack of transparency, comparability, and ESG data, so-called ex-ante challenges, and conflicts of interest, coverage and costs, interactions between providers and rated entities, and lack of transparency around methodologies, so-called ex-post challenges.
“To address ex-ante challenges, CDP recommends that policymakers adopt mandatory disclosure requirements based on harmonised and interoperable corporate sustainability disclosure standards,” said Bertazzi.
The non-profit has seen progress in the past few years on mandating disclosures, with the International Sustainability Standards Board (ISSB) that has released the global baseline standard for climate-related financial disclosure.
Significant work is instead necessary to address ex-post challenges and ensure ESG ratings can fully support decision-making processes for sustainable investing.
Policymakers should adopt a common baseline to define ESG ratings, giving clarity to investors that are baffled by lack of data, and to compare those data and inconsistencies.
ESG data, in fact, tend to be inconsistent because disclosure on sustainably is not mandatory, impacting ESG ratings, net zero metrics, and biodiversity risks assessments, according to the report.
Asset managers have “expressed their appetite” for a larger volume of granular, and even raw, ESG and net zero climate transition data, interviews with CDP for the report showed.
But managers also worry about companies cherry-picking their ratings to mislead investors (greenwashing), it added.
Moreover, investors often struggle to find climate-related information for certain geographic areas, sectors, and enterprise population, as non-listed companies, the report said.