French and Dutch regulators proposed new regulations to improve the transparency of how ESG data is collected and ESG ratings are calculated. The move follows consolidation in the industry, with more US firms gaining control over European ESG providers. The proposed new regulations would require ESG data providers to have permanent establishments in the EU.
The French securities regulator Autorité des marchés financiers (AMF) and its Dutch counterpart, the Autoriteit Financiële Markten (AFM), issued a joint position paper calling for new legislation that would grant the European securities regulator, European Securities and Markets Authority (ESMA), supervisory powers over ESG data providers.
ESG data providers would be required to disclose the sources of their data, their data collection processes, how missing data is estimated, and their data quality controls, among other things. ESG data providers would have to detail their governance and internal controls, their compliance practices for managing conflicts of interest and their review functions for monitoring methodologies, models and key rating assumptions. The proposed regulation would require disclosure of fees to ensure that “the provision of sustainability-related products/services are not discriminatory.” European regulators would report on how ESG data fees evolve over time.
The AMF and AFM paper stresses that regulation should cover ESG data providers more broadly than solely than those that produce ESG ratings. All ESG data providers should be included in the new regulation: “The AMF and the AFM are also of the view that the scope should cover the diversity of ESG-related products/services since risks in the market for SSPs apply not only for ESG rating services, but also for the related services such as the provision of ESG data, scorings, controversies, scenario analysis, taxonomy-related tools, and screenings.” ESG research providers such as banks which also offer ESG data would also be subject to the new regulation.
In our recent review of ESG data, we identified four different varieties of ESG data, the most prevalent being ESG ratings providers. It is likely that all varieties of ESG data would be covered by the new regulation being proposed by the AMF and AFM.
One of the concerns of European regulators is ongoing consolidation within the ESG data space. The position paper suggests that dependence on fewer providers may lead to a less efficient market with “higher prices, barriers to entry, lower competition, reduced innovation and poor coverage of smaller issuers.”
An unvoiced concern is that consolidation has increased the influence of US-based financial services providers. As one example, Morningstar’s recent acquisition of Amsterdam-based Sustainalytics encompasses what were once ten European ESG data providers. In an attempt to address the growing influence of US-based firms, the proposed new regulation would require ESG data providers to establish operations in Europe.
The AMF/AFM paper cites estimates from UBS Evidence Lab that the ESG data space “could more than double to over $5 billion by 2025 (…), as institutional investor interest grows in the wake of the Covid-19 pandemic.”
European concern partly reflects ESG data quality issues, which is an anxiety shared by institutional investors. A recent Blackrock survey of asset owners found that poor quality ESG data and analytics were viewed by respondents as the biggest barrier to sustainable investing. The increased disclosure proposed by the AMF and AFM would provide some help, but any institutional investor might easily obtain such information from current or prospective ESG data vendors.
We suspect that a more potent motivation for European regulation is the increasing control of ESG data by US-based firms. The proposed ESG data regulation is modeled on European regulation of credit rating agencies put in place in 2009. That ESG data providers now warrant such attention reflects the growing importance of ESG investing, and the increased power of ESG data.
Our view is that relentless consolidation in the number of ESG providers has served to greatly reduce the inconsistencies associated with multiple rating methodologies, as well as strengthening the operational controls associated with ESG data collection. Technology is also playing a role as AI enriches the data with a greater variety of sources, increasing timeliness and adding granularity. At the same time, the broader set of sources facilitated by AI is creating more balance between environmental, social and governance factors. Meanwhile asset managers are investing in their own internal ESG capabilities, adding ESG analytic talent which will reduce undue influence on external ESG ratings and data.
It is unlikely, however, that these underlying trends will provide sufficient solace to European regulators miffed by the growing influence of US-based firms. For this reason, we believe that the AMF/AFM proposals have a high probability of ultimately being enacted.