(Reuters) – Global regulators took a first step on Monday to unlock the "black box" for corporate environmental, social and governance values, suggesting formal oversight of a sector that helps channel trillions of dollars into climate-friendly investment funds.
Despite growing influence, ESG ratings and data providers are largely unregulated, lack transparency in their methods, offer uneven coverage and have potential conflicts of interest, says the International Organization of Securities Commission, which groups market regulators from the US, Europe and Asia.
Asset managers operating ESG-focused funds are increasingly relying on around 160 rates globally to help select equities and bonds, raising investor protection issues, IOSCO said. However, users generally do not perform any formal verification of ratings, calling the process a "black box."
"Users have signaled that having multiple ESG ratings and computer products can cause confusion, raising serious questions about relevance, reliability and greenwashing," said Ashley Alder, President of IOSCO and Head of Hong Kong Securities Watchdog.
Greenwashing refers to companies that have exaggerated their green references in an attempt to attract investors.
The sector has seen a rapid consolidation with US domicile. companies such as MSCI, S&P and Morningstar that are leaders in the package.
IOSCO Consultative Paper recommends that regulators consider formally regulating the sector, corresponding to similar features with credit rating agencies in the aftermath of the global financial crisis more than a decade ago when similar concerns
Regulators can encourage industry to develop and follow codes of conduct said the watchdog.
"ESG ratings and data product providers may consider targeting high levels of disclosure and transparency in their ESG ratings and data products, including their methods and processes," IOSCO said.
ESG ratings can keep internal records to back up their ratings and provide assurance the score is "free from political or economic strain", says IOSCO.
Graduates should ensure that there is no conflict of interest between selling grades to companies with which they may also have a business relationship, IOSCO said.
"Financial market participants may consider exercising due diligence on ESG ratings and computer products they use in their internal processes," it added.
MSCI said it reviewed the IOSCO report. are determined to define and apply sound practice in our business, "it said.