Regulators take aim at ESG ratings in fight against greenwashing

Global regulators are taking aim at sustainable investing ratings as officials work to stamp out greenwashing in the fast-growing environmental, social and governance investment sector.

Government treasury departments and the EU are already considering stricter parameters for rating agencies providing sustainability assessments of companies and securities, according to the head of ESG at the UK’s Financial Conduct Authority.

“The whole investment chain has to get involved, and ratings have to be regulated too,” Sacha Sadan said at an industry event in London this week, warning that regulators would be focusing on transparency, conflicts of interest and requirements to demonstrate the validity of metrics.

“People do get surprised when they see certain stocks [such as oil and gas] in a portfolio that’s an ESG best-in-class . . . and that’s why as a consumer regulator looking after people we have to make sure that is correct.”

The industry faced a trust issue on ESG as the lack of clear definitions had confused many consumers, and some investment professionals, about what these strategies actually promised to deliver, Sadan said.

“I’ve been in many rooms where people say: ‘I’m ESG compliant’. And I say: ‘I’ve been in this industry for a while and I have no idea what that means’,” he said.

ESG investing has ballooned globally to have just under £3tn under management in 2021, as individuals and organisations buy into the idea that capital can be better aligned with social and environmental objectives.

However the nascent industry has been dogged by claims of greenwashing — companies inflating their sustainability credentials in order to attract capital or customers.

HSBC executive Stuart Kirk reignited the debate about the validity of ESG considerations for investors in a speech at a Financial Times conference last week. Kirk, a former FT journalist who has since been suspended as the bank’s head of responsible investing for the asset management division, claimed that central banks and policymakers were over-egging the financial risks of climate change in an attempt to “out-hyperbole the next guy”.

“Who cares if Miami is six metres underwater in 100 years?” he said. “Amsterdam has been six metres underwater for ages, and that’s a really nice place. We will cope with it.”

While the comments have divided professionals, Sadan said the consensus from regulators was that the industry needed to move faster to address climate risks.

“There always is a risk [of groupthink] in one way or another,” he said. “But I’m not sure I would have made any of the comments that were made, and HSBC certainly made its own comments . . . We need to push very hard in this industry.”

In order to address concerns that some investors have latched on to ESG as a trend without doing the work required to ensure investments measure up, regulators have vowed tighter scrutiny on ESG disclosures and marketing by investment firms.

A 2021 academic study led by researchers at MIT found that “available measures of ESG performance are noisy . . . and there is significant disagreement [between rating agencies] in their ESG assessments”.

Rating agencies attracted controversy in the aftermath of the 2009 financial crisis, when they gave prime ratings to highly risky mortgage-backed securities that ultimately blew up and tanked global markets. A 2011 US government inquiry concluded that the leading “credit rating agencies were key enablers of the financial meltdown”.

The US securities watchdog is among the regulators taking a tougher stance on the industry’s ESG claims. Earlier this week the Securities and Exchange Commission announced a $1.5mn fine on BNY Mellon’s fund management division for allegedly providing misleading information on its ESG investments. It also promised tighter rules on disclosures and marketing for ESG funds. Fund manager DWS is being probed over greenwashing allegations by regulators in both the US and Germany.

“We see that market conduct standards are necessary, but the question is where do you start from as a regulator? We think starting with a code of conduct and developing a regulatory framework from there would make the most sense,” said Neil Acres, global head of government and regulatory affairs at MSCI.

“We welcome well-calibrated rules that emphasise the transparency, integrity, and the independence of ESG ratings,” Sustainalytics, one of the biggest providers of ESG data, said. The rating agency S&P Global said it welcomed dialogue between policymakers and ESG product providers.

Industry players complain that regulators have not been clear on standards, raising the likelihood of misinterpretation. Sadan said efforts were under way to better co-ordinate officials’ messages across borders.

“Being in the room with the SEC, being in the room with the EU, [means] making sure they’re speaking from one voice. And trust me, it’s not one voice. We’re trying to go from being seven voices to about one and a half voices. This will make [investors’] life easier and our life more impactful,” he said.