Market Characteristics of ESG Rating and Data Providers in the EU: Do we need regulatory Safeguards for ESG Rating Products?

Abstract

The market for ESG rating and data providers is at least as fragmented as it is promising. At the same time, there is a consensus in the market that the level of methodological transparency is not yet satisfactory. Therefore the European Securities and Markets Authority (ESMA) is currently assessing the need to introduce regulatory safeguards for ESG rating products. From the users’ point of view this would be more than desirable, especially in view of the low correlation between the ratings of different providers. It would reduce the costs of licensing and increase trust in supplied data. Whether this is desirable from the EU’s point of view with regard to the resulting market changes on the supplier side remains questionable.

Introduction

The market for ESG rating and data providers is an immature but increasing market. There are currently 59 active ESG rating and data providers in the European Union.

In addition to larger non-EU firms that offer a more comprehensive range of services and hold significant market shares, a significant number of smaller, specialised EU firms have established themselves in recent years.

As each company uses individual methodologies to determine ratings and scores and has different approaches about the transparency of their data, users are facing different shortcomings.

Therefore the European Securities and Markets Authority (ESMA) is currently assessing the need to introduce regulatory safeguards for ESG rating products.

ESMA Call for Evidence

In a letter dated 12 November 2021, ESMA conducted a call for evidence to obtain information on the nature and size of the market for ESG rating and data providers in the EU. The aim was to present the market situation in relation to the European Commission’s strategy for financing the transition to a sustainable economy and ESMA’s roadmap for sustainable finance.

A total of 75 financial service providers were surveyed regarding their use of ESG rating and data providers. The results are available as of 24 June 2022.

In the survey, 63% of respondents indicated that they use both ESG ratings and other ESG data products. On average, 50% of respondents already incorporate ESG ratings and/or other ESG data products into the investment decision-making process for all assets under management.

In addition, 77% use more than one provider to increase coverage of companies, compare different ratings and add additional data points to their analysis.

The key selection factors for database providers are data coverage and quality, accessibility, transparency and completeness of analysis, and diversity of performance indicators offered.

Views on Shortcomings in the ESG Rating or ESG Data Products

In general, users tended to agree on some main shortcomings that they identified in their experience with one or multiple ESG rating providers:

Low levels of transparency of methodologies and of data sources
Lack of comparable and standardised data, together with a proven low correlation between ESG ratings provided by different entities
Low coverage of SME’S
Need for an alignment of definition and approaches concerning what is meant by “ESG” and what is the purpose of an ESG rating
Delays in updating the underlying data of ESG ratings, and frequent unavailability or late responsiveness to error reporting or comments submitted by companies
“US-bias” resulting from the increasing market concentration
Price increase due to increase in market concentration

Conclusion

The market for ESG rating and data providers is at least as fragmented as it is promising. At the same time, there is a consensus in the market that the level of methodological transparency varies between providers and is not yet satisfactory. The methods are often seen as too complex and unclear, and providers are sometimes unable to reflect how their results were determined. This raises questions about the degree of reliability and argues for the need for regulation.

From the users’ point of view this would be more than desirable, especially in view of the low correlation between the ratings of different providers. It would reduce the costs of licensing and increase trust in supplied data.

In terms of supply, however, regulation would inevitably lead to a reduction of providers in the market. Small, specialised providers in particular would probably only be able to take insufficient account of ESMA’s requirements. This would further increase the already existing consolidation in the market and shift more market shares to established US companies such as MSCI, S&P and Sustainalytics.

Whether this is desirable from an EU perspective remains questionable.

About the Team

Nadine, Wolfram and Timm combine competences from various areas such as operations, corporate communications, business development, finance, regulation, accounting and consulting.

As the Bloomberg for green tokens, they create a holistic database for tokenized, sustainable assets and ecosystem-based tokens that offers a trusted, one-stop solution for investors and companies.