What trust would one put in financial information that is solely reserved for investors and not published, that no independent analyst could challenge, given that the regulator would have no way of guaranteeing its veracity either?
For many years, the European regulator has been multiplying initiatives that aim to create a set of rules to organise ESG investment, whether this involves defining climate benchmarks, organising reporting, or, in the future, labelling funds.
All of these projects have one characteristic – they rely on highly intensive use of private data that allows the most complex regulatory requirements to be met. Even though the European legislative process includes impact studies on the expected benefits, costs, and consequences of the proposed texts, it is fairly easy to observe that these are almost inexistent when the regulation of ESG investment is involved.
There is in fact no serious study on the competitive restrictions and costs involved in access to data that is often held by a small number of actors who, moreover, are engaged in investment management or index offerings themselves.
Even more surprising: even though extensive serious academic research shows the lack of reliability of ESG indicators, these are a core part of current or forthcoming regulation.
Finally, there is no real proposal for genuine precautions around the use of data for portfolio construction and reporting. The regulator favours window dressing over rigour and effectiveness, and this includes promoting data that are ambitious but not reliable or verifiable, as is the case for example with the Scope 3 carbon emissions data, or pointless with respect to corporate-level environmental assessment, as is the case with carbon intensity defined as a ratio of emissions to market-based corporate value (e.g., Enterprise Value Including Cash).
This phenomenon is not surprising when one considers the current governance of ESG investment topics within the European Commission, where data providers and their partners are overrepresented in expert and working groups on ESG information and investment. When academics participate in the work of these groups, it should be acknowledged that they may conduct consulting missions for the industry, including for data providers.
Is this situation scandalous? Not necessarily. We are not speaking here of a “datagate” where the administration would have fallen short ethically. Ultimately, it is quite normal for private agents who have invested in producing ESG data to wish to promote their use.
On the other hand, it is highly regrettable that the Commission has not decided to establish its own competencies and delegates the defence of the public interest to the industry.
The European legislator should draw all the necessary conclusions from this conflict of interest and from the limitations of the proposed pro-data regulations, which all suffer from one common defect, namely the lack of transparency on the methods and the construction of many indicators whose usage they require or encourage and, de facto, the lack of guarantee on their quality and integrity.
In effect, many of the indicators used in the Sustainable Finance Disclosure Regulation (SFDR) and Benchmark Regulation (BMR), which covers index sustainability disclosures and minimum standards for construction of the regulatory sanctioned climate transition and Paris-Aligned Benchmarks (PAB), rely on modelling that, due to their private nature, are not included in contradictory public debate.
Subject to confidentiality clauses, only clients have access to details on the data that allows the scores and indicators used in reporting and portfolio construction to be calculated.
What trust would one put in financial information that is solely reserved for investors and not published, that no independent analyst could challenge, given that the regulator would have no way of guaranteeing its veracity either?
At a time when extra-financial information is being put on a par with financial information in investment processes and fund distribution, such a lack of credibility is difficult to accept. It is certainly not new regulation on the governance of ESG data providers that will improve the quality of extra-financial information.
As has been the case with financial ratings agencies, it will lead to new barriers to entry being created to the benefit of the oligopolies in place. The regulator should instead promote the reinforcement of market efficiency.
This recourse to the market would be a welcome admission of modesty from the regulator which has probably overreached and shown dangerous hubris by taking ownership for sweeping fine-grain prescriptions that appear to deny investors the responsibility of due diligence.
Of course, market efficiency requires transparency, and it is indeed the historical role of the regulator to improve transparency and reduce information asymmetry. We think that any publication of an ESG score, of an evaluation of a principal adverse impact, or of a climate trajectory at portfolio level, should be accompanied by the stock-level details that allow this overall indicator to be recalculated, and therefore possibly to be challenged.
Such criticism motivated by various interests will allow the quality of the information to be strengthened. The market’s capacity to function efficiently will do more to reduce adverse selection phenomena than statements of adequate conflict of interest management and other governance bells and whistles.
It is high time that the market fulfilled its role in the area of ESG information and it is urgent for the regulator to stop making false promises on the “greening” of portfolios and to allow investors to do their work of environmental impact evaluation.
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