The International Organization of Securities Commissions (IOSCO) has issued its final report on ESG ratings and data providers with further detail on how the lack of transparency, conflict of interests and reliability of data could be improved.
In July, IOSCO began consulting the industry for its Report on Environmental, Social and Governance (ESG) Ratings and Data Product Providers where it issued 10 recommendations for improvements in the ESG ratings space with a focus on how securities regulators could play a role.
Today, IOSCO has issued it’s final report on the consultation with feedback from the industry on the recommendations and finer details.
Overall, it reiterated previous findings that reliability of data and communication between ESG ratings and data products providers were key issues.
It found:
- There is little clarity and alignment on definitions, including on what ratings or data products intend to measure;
- There is a lack of transparency about the methodologies underpinning these ratings or data products;
- While there is wide divergence within the ESG ratings and data products industry, there is an uneven coverage of products offered, with certain industries or geographical areas benefitting from more coverage than others, thereby leading to gaps for investors seeking to follow certain investment strategies;
- There may be concerns about the management of conflicts of interest where the ESG ratings and data products provider or an entity closely associated with the provider performs consulting services for companies that are the subject of these ESG ratings or data products;
- Better communication with companies that are the subject of ESG ratings or data products was identified as an area meriting further attention given the importance of ensuring the ESG ratings or other data products are based on sound information.
Recommendations for regulators
IOSCO said in the final report regulators should consider “establishing regulatory expectations around good practices in corporate governance to help ensure appropriate independence and objectivity” which would turn into a greater level of confidence when using ESG ratings. However, over-reliance on ratings should be avoided.
Specifically, IOSCO said regulators could require providers to identify and disclose conflicts of interest, question whether the data they rely upon on are publicly disclosed, or based on industry estimations, ask if they adhere to the provider’s written policies and procedures and also offer facilities to report complaints.
It also suggested regulators could consider encouraging industry participants to develop and follow voluntary common industry standards, and IOSCO could play a role in putting together such standards.
Recommendations for ESG ratings and data products providers
IOSCO said feedback indicated this is an area that needs improvement in terms of “reliability, comparability and interpretability” of ESG ratings.
Referring back to the regulatory recommendations in terms of adhering to written policies and procedures, IOSCO said ratings providers need to consider adopting and implementing these to help ensure transparency and consistent quality of their ratings and data products.
It said: “ESG ratings and data products providers could consider adopting, implementing and providing transparency around methodologies for their ESG ratings and data products that are rigorous, systematic, applied continuously while maintaining a balance with respect to proprietary or confidential aspects of the methodologies.”
IOSCO also highlighted the need for providers to identify and mitigate or disclose potential conflicts of interest that “may compromise independence or objectivity of ESG ratings”.
It again suggested adopting written internal policies and procedures to disclose or mitigate anything that may “influence the opinions and analyses ESG ratings and data products providers make or the judgment and analyses of the individuals they employ who have an influence on their ESG ratings or data product decisions.”
Structuring reporting lines and compensation arrangements for staff to eliminate or “appropriately manage” actual and potential conflicts of interest was also flagged.
In terms of transparency, IOSCO recommended as a priority making public disclosures for their ESG ratings. It also urged providers to clearly label ESG ratings by addressing the following:
- The measurement objective of the ESG rating or data product;
- The criteria used to assess the entity or company;
- The KPIs used to assess the entity against each criterion o the relative weighting of these criteria to that assessment;
- The scope of business activities and group entities included in the assessment;
- The principal sources of qualitative and quantitative information used in the assessment as well as information on how the absence of information was treated;
- The time horizon of the assessment; and o the meaning of each assessment category (where applicable)
Recommendations for market participant users of ESG ratings and data products
In terms of their due diligence, IOSCO encouraged investors to improve their processes with regards to the gathering and reviewing of information relating to the ESG ratings they use in their internal processes.
This includes the sources of information used in the product, the timeliness of this information, whether any gaps in information are filled using estimates, and if so, the methods used for arriving at these estimates, as well as whether the methodologies or criteria are “science-based, quantitative, verifiable, and aligned with existing standards and taxonomies, the relative weighting of these criteria in the process, and the extent of qualitative judgement”.
Recommendation on how covered entities could consider interacting with ESG ratings and data products provider
The final recommendation said entities should disclose information on their ratings in a manner that is “consistent, predictable and easy to access” by perhaps including a dedicated section on their website.
It also flagged it’s work with the IFRS Foundation on the establishment of the ISSB, as announced at COP26.
“IOSCO considers that the newly launched ISSB can deliver a global baseline for investor-oriented sustainability-related disclosure standards focussed on enterprise value creation, which jurisdictions could consider incorporating or building upon as part of their mandatory reporting requirements as appropriate and consistent with their domestic legal frameworks.
“These efforts … are intended to drive much-needed international consistency and comparability in sustainability-related information. In turn, this information could become an essential part of any methodology underpinning the development of ESG ratings or data products.”
