Should regulation for ESG data be prescriptive?

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The market for environmental, social and corporate governance data providers would benefit if regulation was more prescriptive, according to asset manager Insight Investment.
Carly Thomas, ESG analyst at Insight Investment, said there was a need for assurance and agreed methodologies.

Speaking at a webinar organised by the asset manager on Wednesday, she said: “Obviously the market was in its infancy just a few years ago, but it has grown so rapidly it is a marathon that we're all trying to sprint because you just can't keep up.”

This growth means principles-based regulation is no longer appropriate, she argued.
“Back then, a principles-based regulation was suitable because we were starting from a very low point. But now everybody has integrated ESG [in their investments]. Every single client I speak to wants to talk to me about responsible investment. We need to be able to compare issuers on a like-for-like basis. It needs to be a level playing field,” said Thomas.

Data issues: Too wide-ranging for principles-based approach?

Thomas’s comments followed a number of concerns with the ESG data, ranging from data coverage and data quality to  inadvertent risks and dispersion.

She said coverage of ESG has been increasing over the years, but not all data providers have the same reach. “There are lots of data gaps. Depending on which benchmark you use you have different coverage there as well.”

Thomas also said ESG data was not always of the best quality because the data might have been estimated or the issuer that has published it “might not be very good at calculating data points and may not have audited it, for example”.

She also pointed to weaknesses of data due to incomplete, irrelevant or stale data as sometimes data is only updated once a year.

On inadvertent risk, Thomas warned of the risk of concentration: “If you're relying on just a limited number of data points, what are the risks of playing too much on those and not thinking about other ones?”

Thomas also highlighted that ESG ratings could be dispersed where, for instance, one provider may have a different rating to another for the same issuer. She argued this is not a one-off issue. “We see it very frequently,” she said.

Market players should all be able to look at issuer disclosure and understand the ESG risks, she noted, adding: “We do really hope that in future regulation, that is much more prescriptive… we don't have to unpack the data of working backwards to identify what that actually means.”

Will regulation hinder innovation?

The Financial Conduct Authority recently said there was a “clear rationale” for bringing ESG data and ESG ratings providers into its remit.

If the government decides to extend the FCA’s regulatory perimeter to include these firms, a consultation will follow. The FCA said in the meantime it would support an interim voluntary Code of Conduct to be developed by industry participants.

ESG data providers MSCI and Morningstar Sustainalytics agreed with the FCA’s suggested voluntary approach, but Morningstar Sustainalytics went further and called for a principles-based approach to regulation.

Morningstar Sustainalytics argued that more detailed regulation “could potentially hinder innovation and create barriers to entry”.

Should ESG data regulation be prescriptive or principles-based?

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