Credit Suisse Group AG’s sustainability chief added his voice to a growing chorus of industry professionals calling for the regulation of ESG ratings.
Daniel Wild, global head of ESG strategy at the Zurich-based bank, says there’s currently inadequate oversight of the firms that grade businesses on their environmental, social and governance metrics. Neither the data the ratings firms use nor the approaches they take are clear, he said.
“It makes a lot of sense to put more pressure on the quality of these ratings, on the transparency of the ratings,” Wild said in an interview. “At least you want to know why a rating ended up where it did, and what their underlying assumptions were.”
The market for ESG products has ballooned to over US$35 trillion, spawning a cottage industry of support services that offer analysis and rankings of the sustainability claims being made.
Others besides Wild have questioned the lack of uniformity in ESG ratings. NN Investment Partners, which is being acquired by Goldman Sachs Group Inc, has warned of the “pitfalls posed by ESG ratings.”
The grades are used by the investment management industry to help figure out how sustainable an asset is. That’s as financial professionals grow increasingly anxious at the prospect of being caught greenwashing, which is the term given to inflated or false ESG claims.
“When you have such a level of discrepancies from one agency to another, it comes with issues, it comes with questions from clients,” said Clemence Humeau, head of responsible investment coordination and governance at AXA Investment Managers. “It is an area where harmonization is needed,” she said.
The Legal Fallout
Regulators have made clear they’re growing less tolerant of sloppy ESG labelling. That point was underscored last month as news spread that the investment unit of Deutsche Bank AG, DWS Group, was the subject of investigations in the U.S. and Germany. According to DWS’s former sustainability head turned whistleblower, Desiree Fixler, the firm inflated the value of its ESG assets. DWS has rejected the claims.
In a recent paper that examined scores given by a number of ESG ratings firms, co-authors led by Florian Berg, a researcher at MIT Sloan, said the information they provide is “relatively noisy.” Companies get “mixed signals,” making it difficult to improve, while investors “face a challenge when trying to identify outperformers and laggards.” Bloomberg LP, the parent of Bloomberg News, also provides ESG ratings but wasn’t included in the study.
The industry doesn’t contest the discrepancies among ratings, said Andy Pettit, director of policy research in Europe for Morningstar, the parent company of ESG ratings provider Sustainalytics. They reflect the different weighting that firms give to E, S and G factors, the different methods they use for doing so and different data.
“Sometimes it’s very quick to compare ESG ratings with credit ratings,” Pettit said. “There are fairly significant differences, both in that ESG ratings typically are offered on an investor-pays model and credit ratings on an issuer-pays, and also credit ratings have obviously been around for a long time and are very established processes in measuring exactly the risk of default, whereas ESG has got so many different factors that you come back to the point that some people put more emphasis on one of those factors than another.”
European Review
The European Securities and Markets Authority, which regulates credit rating companies, has already called on the European Commission to address concerns around the reliability of the ESG ratings market. The industry has so far unsuccessfully tried to regulate itself, with three major attempts over the course of more than a decade now “largely discontinued,” according to a November report by the commission.
ISS ESG, another ratings provider, says it welcomes any steps that bring transparency. But the unit of International Shareholder Services also cautioned against introducing constraints that would make it hard for raters to keep pace with changes in the market.
Maximilian Horster, who heads ISS ESG, said it’s important to avoid “steps that would undermine the ability of the ratings and data providers to produce and deliver the independent and informed ESG research and analysis necessary to address a rapidly evolving ESG landscape.”
According to Wild at Credit Suisse, regulations would help address some basic gaps. He says those using ESG ratings often don’t know whether the information behind the scores is reliable, which entails a number of risks. The Zurich-based bank estimates that just over 8%, or 133 billion francs ($145 billion) of its total assets met sustainability criteria at the end of June.
Even widely accepted metrics such as carbon emissions aren’t treated in a uniform manner, Wild said. “It sounds easy, a carbon footprint measurement,” he said. “But there is no standard how this has to be measured.”
“The underlying data needs to be controlled,” Wild said. “A credit rating is usually based on mostly financial indicators that are heavily controlled through accounting standards and so on. But that’s not the case for ESG information.”
