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Article26 Mar 2021

The ESG Rating Provider Regulation Debate

We highlight the key themes discussed by ESG research analyst Georgina Smartt in her report ESG Rating Providers Proliferate but Is Regulation Looming? – 11th February 2021. Against the backdrop of a regulatory overhaul for ESG financial disclosures for corporates and investors, calls for regulation of ESG rating providers are also growing, which could impact the integration of ESG into the investment process.

Key Points Considered

Should regulation focus on creating consistent comparable ratings?  The current variety in ratings shows the wide range of methodologies in use, particularly considering providers rely heavily on the same company disclosed data. However, if rather than focusing on consistency of ratings, regulation could focus on the transparency of methodologies.  This could avoid the need for a complete overhaul of ESG rating methodologies (and the ratings assigned) and would therefore be less disruptive. Investors increasingly reliant on ESG ratings also need to understand and accept that incorporating ESG data into investment decision-making is more art than science. 

Would regulation eliminate the need for in-house modelling? Georgina looks at how investors using ESG ratings in conjunction with proprietary ESG analysis, provide a deeper dive into a variety of metrics, data and initiatives. This combined approach and an effective engagement strategy can facilitate material ESG integration. She concludes that ‘these findings should form the basis of an effective stewardship and engagement strategy to arrive at a more informed view.’

 

Figure 1. Pros & Cons to a Surplus of Unregulated ESG Rating Providers
Pros Cons
Freedom of interpretation Numerous ESG rating methodologies
Provides a wide spectrum of views on the ESG profile of a company Reduces the comparibility across providers
Large scope of providers Autonomy in changing existing methodologies
Allows access to more localised specialist rating providers, for more nuanced portfolios Reduces the ability to perform back-testing and other quantitative analysis
Competion breeds innovation Opaque methodologies
New tools and technology are being utilised in modelling to provide alternative methods in risk profiling Restricts users understanding of rating drivers. Quality and reliability of ESG ratings require transparency
Large pool of options for M&A opportunities Unchallenged subjectivity
Increases the ESG expertise being integrated into traditional financial data, research and rating providers Unknown scrutiny of interpretation of raw data metrics
Source: Citi Research

 

For more information on this subject, please see ESG & SRI - ESG Rating Providers Proliferate but Is Regulation Looming?.

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation.It is not investment research. The comments expressed herein are summaries and/or views on selected thematic content from a Citi Research report. For the full CGI disclosure, click here.

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