Environmental, social, and governance (ESG) considerations play a crucial role in asset managers' investment decisions for several reasons:
- Financial Impact. ESG factors can significantly affect a company's financial success and long-term viability, which in turn can impact investment returns.
- Investor Demand. Both retail and institutional investors are increasingly seeking investment products that incorporate ESG considerations.
- Regulatory Requirements: Europe has introduced several regulatory measures, such as the Sustainable Finance Disclosure Regulation (SFDR), Corporate Sustainability Reporting Directive (CSRD), EU Taxonomy Regulation, and Shareholders Rights Directive (SRD II). These regulations aim to strengthen ESG reporting, disclosure, and engagement practices, as well as integrate ESG considerations into investment processes.
Due to these developments, asset managers highly rely on ESG data and ratings from external providers and this reliance poses several challenges challenges. To address the pivotal issues ,listed below, a regulatory framework for ESG data and ratings is necessary.
Key Elements of Supported Legislative Proposal:
- Transparency Enhancement. The proposal focuses on enhancing transparency surrounding ESG ratings. It includes aspects like defining the objectives, methodologies, data sources, and ranking systems used by ESG rating providers. This transparency ensures investors can make informed decisions.
- Conflict of Interest Mitigation: The proposal addresses potential conflicts of interest among ESG rating providers, enhancing the credibility and trustworthiness of ESG ratings by imposing stringent requirements to identify and manage such conflicts.
- Complaint Mechanism: The proposal introduces a mechanism for handling complaints related to ESG ratings, allowing individuals and entities to voice their concerns, which promotes accountability and rectification within the industry.
- Fair and Transparent Fees: It establishes fair, reasonable, transparent, and cost-based fee structures for ESG ratings, ensuring that fees align with the value provided. The European Securities and Markets Authority (ESMA) is empowered to intervene in cases of fee violations.
- Regulatory and Supervisory Regime: The proposal sets up a regulatory and supervision regime with authorization, registration, and organizational requirements to enhance the integrity and reliability of the ESG data market and reduce the risk of greenwashing.
However, EFAMA sees some areas for improvement:
- Inclusion of ESG Raw Data. The legislation should cover both ESG ratings and data providers to ensure comprehensive coverage. Raw data, even without an assessment, should be within the legislative scope, as it forms the basis for ESG ratings and lacks standardized reporting and audit standards.
- Clarification of ESG Ratings Definition. The definition of "ESG rating" should align with international guidelines and encompass a broad spectrum of ratings products. The legislation should differentiate between ESG ratings and ESG data products to avoid confusion.
- ESG Ratings Produced by Regulated Financial Undertakings: Article 2(2)(b) should be clarified to exclude any ratings, scores, or data provided by financial market participants, as these are already covered by other regulatory frameworks.
- Enhanced Transparency on Fees: The legislation should specify fee structures to prevent untransparent practices and fee inflation.
- Transparency on ESG Ratings Provision Contracts: A regulatory framework for contracts related to ESG rating provision should be established, ensuring fairness and clarity in contractual relationships between providers and users.
- Strengthening Transparency Requirements in Annex III: Transparency requirements should be further strengthened and aligned with IOSCO recommendations, including disclosure of data sources, KPIs, measurement methodologies, and the scope of assessments.