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Scrutiny on ESG ratings intensifies

Once relegated to a niche domain, ESG ratings have since risen to prominence, wielding considerable influence over investment decisions. However, their newfound power has caught the attention of regulators and policymakers worldwide, prompting intense formal scrutiny. 

Once relegated to a niche domain, ESG ratings have since risen to prominence, wielding considerable influence over investment decisions. However, their newfound power has caught the attention of regulators and policymakers worldwide, prompting intense formal scrutiny. 

The Deepwater Horizon oil rig disaster in 2010, with its devastating environmental consequences, played a pivotal role in transforming the financial industry’s approach to ESG (Environmental, Social, and Governance) ratings. Until then, sustainability ratings were a niche business for companies providing data and indices for financial markets. However, the Gulf of Mexico spill brought ESG risks to global attention, making investors more cautious about companies exposing them to such risks. 

In response to growing ESG awareness, the ESG ratings sector has evolved significantly. ESG ratings now heavily influence which stocks and bonds are included in the $2.8 trillion of investment funds marketed as sustainable. This newfound power, however, is attracting formal scrutiny from regulators and politicians worldwide. 

European lawmakers are considering legislation to require ESG rating agencies to separate from their consultancy arms, disclose methodology details, and register formally with authorities. India’s securities regulator is demanding that agencies publish their methodologies, while in the U.S., Republican politicians are concerned that ESG data providers may influence investors against certain industries.  

The scrutiny extends to potential conflicts of interest, as some ESG data giants offer consultancy services to improve ratings and charge companies to display their ratings on financial products. Additionally, the gap between what ESG ratings assess and what they demonstrate is causing confusion among investors. 

As regulatory attention intensifies, the handful of dominant ESG rating agencies faces challenges over market concentration, potential influence from data subjects, and defining what constitutes a “green” investment. The ESG rating landscape is poised for change, driven by demands for transparency and accountability in this vital area of sustainable finance. 

Read more: https://www.ft.com/content/fbe10867-fea1-4887-b404-9f9e301e102e 

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