Resistance to EU regulation on ESG investing appears to be on the rise, with the likes of ratings provider MSCI, and the London Stock Exchange opposing full-fledged regulations. Responses to its most recent consultation with market participants, the consensus of opinion seemed to suggest guidelines on appropriate conduct would be preferable.
Financial firms opposing potential mandatory regulations appear to favour self-governing principles of good conduct. Reasons cited to point to competitive pressures from a rapidly developing market for ESG ratings services.
The need for more regulation was affirmed by a majority of the non-ratings agency respondents to the consultation, with ratings inconsistencies and a lack of transparency cited as major problems with the market.
While the sector is in its early stages of development, the prospect of regulation has already had the positive effect of identifying potential greenwashing claims. Additionally, growth in ESG investing has not been deterred by this, or by the lack of disclosure from investees thus far, which may prompt regulators to act sooner.
Consultation with market participants like ESG and credit ratings agencies (CRAs), and other industry stakeholders, was undertaken to understand how CRAs incorporated ESG factors in their credit ratings. The intended outcome was to determine what policy initiative was needed on ESG and sustainability ratings used in credit markets.
Self-regulation preferred to regulatory oversight in a nascent market
MSCI’s response to the consultation seemed to suggest competitive pressures were not conducive to regulation. It cited a nascent market and rapid development in services in the ESG ratings space as better suited to an industry supported code of good conduct instead. This, it suggested, could be better handled by the International Organisation of Securities Commissions (IOSCO).
IOSCO describes itself as “the international body that brings together the world’s securities regulators and is recognized as the global standard setter for the securities sector”. Responding to a similar consultation conducted by IOSCO in September 2021, MSCI expressed a similar opinion, stating “In a nascent, rapidly developing market, global principles of conduct for ESG ratings would be more effective than overly prescriptive and point-in-time rules”, and asked that “The independence of ESG ratings should be protected against interference in the ratings and methodologies”.
Unsurprisingly, the responses to the EC consultation from the likes of Morningstar and S&P Global were similar, suggesting a form of self-regulation as well. The industry is most likely under increasing pressure from investors looking for better clarity on underlying data and ratings methodologies, and from regulators looking to do something about it.
Consultation results reflect resounding need for more oversight
Overall the results of the consultation revealed that ESG ratings were relied on heavily, used to make decisions on the impact companies had on society and the environment, with a heavy preference (86%) for those providing analysis and management of risks. A low opinion on the functioning of the market was reflected in poor views of methodologies used by providers, as well as a lack of correlation of ratings and potential conflicts of interest.
Regulatory intervention was seen as necessary by most (94%), mainly dealing with transparency in methodology, with most ratings agencies being subjected to a minimum disclosure requirement. The action taken by the EC on ESG ratings regulations will likely also impact the work being done by the European Securities and Market Authority (ESMA) on sustainability reporting standards.
Industry consultation and debate on proposed rulemaking is an essential part of legislation governing heavily regulated industries, like financial services. Pushback from participants is also part of the process, however a lack of regulation, or allowing self-regulation, can often lead to larger crises, accompanied by expensive associated remedies or penalties.
