ESMA identifies ESG rating shortcomings  

June 30, 2022

The European securities markets watchdog has identified a lack of transparency around methodologies of ESG ratings and providers, as well as insufficient granularity of data. 

The European Securities and Markets Authority (ESMA) has highlighted a number of shortcomings around ESG ratings and data used in the industry.  

In its letter to the European Commission (EC), ESMA provided findings from a recent  Call for Evidence to gather information on the market structure for ESG rating providers in the European Union. 

With a total of 154 responses, ESMA found that users of ESG ratings are selecting several providers to increase coverage, either by asset class or geographically, to receive different nature of ESG assessments. 

According to ESMA, the depth and breadth of data coverage is the most commonly sought attribute in an ESG rating provider for 70% of ESG rating users. The second most sought after attribute (34%) was data quality and transparency of methodologies and data. 

In the letter, ESMA chair Verena Ross said the importance of this attribute was also often mentioned as a key factor for reputational risk management and transparency to the users' clients. 

However, most respondents cited shortcomings in their interactions with the rating providers, particularly on the level of transparency for the rating, the timing of feedback or the correction of errors. 

Through its responses, ESMA identified a lack of company coverage, insufficient granularity of data, and a lack of transparency around methodologies of ESG ratings and providers. 

The lack of coverage on industry, type of entity and granularity of data, is particularly an issue for SMEs and non-listed companies, and has a “fundamental impact on the usability and relevance of ESG ratings”, Ross wrote. 

The European securities markets watchdog’s chair also explained that low levels of transparency of methodologies and data sources were the most relevant factors hampering the reliability of the final ratings and their comparability between ESG rating companies.  

“Lack of comparable and standardised data, together with a proven low correlation between ESG ratings provided by different entities, and a misalignment on the definition of ‘ESG’, were identified as major challenges,” Ross wrote. 

This is as data used by a number of ESG rating providers is drawn exclusively from publicly available sources, which means SMEs can be disproportionally disadvantaged when it comes to levels of coverage, according to the regulator’s letter. 

ESMA’s Ross added that the feedback appears to be indicative of an “immature but growing market, which following several years of consolidation, has seen the emergence of a small number of large non-EU headquartered providers”.  

The European securities authority will continue to support the EC in the assessment for introducing regulatory safeguards for ESG ratings. 

Reflections from Minerva CEO, Sarah Wilson

Minerva has long supported the transparency of the ESG rating industry. Certainly, it is important that investors understand what they are buying when they solicit our services.

The subjectivity of ESG, sustainability, and materiality means that each investor, and indeed each regulator, will always approach ESG investing in a different way. There will always be grey areas and debates. 

Transparency is a must, but transparency does not mean conformity. Standardisation of the ESG rating industry must steer clear of 'off-the-shelf' ESG ratings, allowing for differences in the methodologies and definitions of rating providers. Minerva prides itself on providing 'bespoke as standard' services to our clients. Preserving our rigorous, bottom-up approach to capturing the nuance, products, and values of individual companies will be important as the ESG space grows and evolves.