Increased transparency and access to underlying data are among the new ESG data and ratings rules that are required, as the investment fund sector has become increasingly reliant on external providers, an industry lobby group has said.
The Brussels-based European Fund and Asset Management Association (Efama), which represents the interests of the European investment management industry and asset managers, published its position focusing on enhancing transparency, managing conflicts of interest and introducing complaint mechanisms, among other key elements, on Friday 1 September 2023.
This came against the backdrop of the growing significance of environmental, social and governance (ESG) considerations in asset management, including the Sustainable Finance Disclosure Regulation, Corporate Sustainability Reporting Directive, EU Taxonomy Regulation and Shareholders Rights Directive (SRD II), alongside established investment process frameworks like Ucits and AIFs.
As a result, asset managers increasingly rely on external ESG data and ratings providers.
Challenges and the need for regulation
This heavy dependence poses a variety of challenges, underscoring the need for a robust regulatory framework governing ESG data and ratings, argued Efama.
The legislative proposal, backed by industry stakeholders, targets several pivotal issues. It calls for enhanced transparency by requiring ESG rating providers to clearly define their objectives, methodologies, data sources and ranking systems.
Such clarity, Efama reasoned, will enable investors to make more informed decisions. The proposal also sought to rigorously manage potential conflicts of interest, thereby bolstering the credibility and reliability of ESG ratings.
In addition, the group called for a formal complaint mechanism to be established to create a channel for individuals and entities to voice their concerns, thus promoting accountability within the industry.
Efama is also advocating for fair, transparent and cost-based fee structures for ESG ratings.
The European Securities and Markets Authority is authorised to intervene in cases of fee violations. Furthermore, a regulatory and supervisory framework is in place, incorporating registration, authorisation and organisational requirements to bolster the integrity of the ESG data market and minimise the risk of greenwashing.
Areas for improvement
While Efama said it broadly supports the legislative proposals for ESG ratings and data providers, the association identified multiple areas for improvement to establish a more comprehensive and effective regulatory framework.
Firstly, Efama emphasised the importance of including not just ESG ratings but also raw data providers in the legislation. The association argued that this raw data, even without an evaluative layer, warrants legislative scrutiny, as it forms the backbone of all ESG ratings and currently lacks standardised reporting and auditing protocols.
Secondly, Efama called for a clearer definition of “ESG rating,” one that aligns with international standards. The association also advocated for clear differentiation between ESG ratings and data products to prevent any confusion.
Thirdly, Efama sought an exclusion clause in Article 2(2)(b) of the draft regulation to prevent overlaps with existing regulatory frameworks. This is specifically in regard to ratings, scores or data supplied by regulated financial entities.
Fourthly, Efama urged lawmakers to mandate greater transparency in fee structures for ESG ratings, with the aim of preventing opaque practices and fee inflation.
Lastly, the association pushed for strengthened transparency requirements, aligned with recommendations from the global regulators club Iosco. This would include the disclosure of data sources, key performance indicators, measurement methodologies and the scope of assessments.
The full report is available here.