Although the use of environmental, social and governance (ESG) ratings is varied and growing, it is still a nascent sector with many issues, particularly around disclosure and market understanding, according to the Financial Markets Standards Board’s (FMSB) Spotlight Review.
The Review, which examines ESG ratings methodologies and data collection processes, notes that ESG ratings assist the development of a healthy market ecosystem by providing an additional and external source of due diligence and expertise. However, their prominence also means that ESG ratings have real impacts on issuers and investors.
The list of challenges included limitations in user understanding of the objectives of ESG ratings and the measurements as well as outcomes including whether ratings are risk-based or assess “double materiality”.
There was also a lack of transparency and comparability of ESG methodologies including the role of controversies, manageable versus unmanageable risk and how data gaps are treated.
In addition, there was a dearth of robustness and quality of underlying data informing ratings which has been compounded by inconsistent corporate disclosure.
Against this backdrop, the Review seeks to promote greater transparency of ESG ratings methodologies and data collection processes and builds on an existing body of work produced by regulators, standard-setters and industry participants.
It focuses on issues in four key areas: output/objectives of ESG ratings; data inputs; methodology; and the post-assessment rating process.
“ESG ratings are an important tool for investors when making investment decisions related to managing exposure to ESG-related risks,” said Myles McGuinness, CEO of FMSB. We hope that this Spotlight Review can help to support increased transparency around collection processes and methodologies as a means of facilitating comparability of ESG ratings.”
Caroline Haas, chair of the FMSB ESG Ratings Working Group and Head of Climate and ESG Capital Markets at NatWest Markets, added, “Improved disclosure and transparency are key for market participants to understand the significance of different ratings in a diverse landscape.
This Review seeks to increase the transparency of ESG ratings methodologies and data collection processes to promote user understanding, aid comparability across providers, improve trust in ratings and thereby support informed allocation of capital.”
