As ESG becomes an ever more important factor for investors and issuers alike, European securities regulators are calling on legislators to step up oversight for ESG ratings.
In a letter to the European Commission (EC), the European Securities and Markets Authority (ESMA) said that growth in the demand for ESG ratings and assessment tools should be matched by regulatory requirements designed to ensure their quality and reliability.
“The market for ESG ratings and other assessment tools is currently unregulated and unsupervised,” ESMA said.
“When combined with increasing regulatory demands for consideration of ESG information, there are increased risks of greenwashing, capital misallocation and products mis-selling,” it warned.
Additionally, it noted that ESG ratings differ widely across providers, which has implications for ESG benchmarks, “with the choice of ESG rating provider significantly impacting the constituents of those indices.”
This also contributes to investor confusion, given that companies in highly polluting industries “can obtain high environmental scores from some ESG rating providers,” the letter said.
“Considering current growth trends in Europe in sustainable investing and passive investment products such as ETFs, measures aiming to reduce the risk of capital misallocation will become crucial to facilitate the transition to a more sustainable financial system,” it said.
To address these growing risks, ESMA made a number of recommendations, including a standardized, legally binding definition of ESG ratings.
It also suggested that regulation should be extended to ESG ratings, modelled on the regime for credit ratings.
For instance, it said that companies that issue ESG ratings should be required to be registered and supervised.
“This would ensure that these gatekeepers of ESG ratings and assessments are subject to a common core of organizational, conflict of interest and transparency requirements,” it said.
And it recommended that the ratings themselves be subject to specific requirements.
Adopting these sorts of measures should be enough to “address the risks of greenwashing, capital misallocation, conflicts of interest and product mis-selling that may arise in the future,” it said.