85% of Financial Institutions Leverage ESG Ratings Amid Global Push for Regulatory Alignment, CDP Report

Environmental, Social, and Governance (ESG) ratings and data products have become essential tools for financial institutions (FIs) to assess portfolio performance and environmental impact. In 2023, 85% of FIs disclosed climate-related opportunities with potential financial or strategic impacts, with $4 trillion in combined assets recognizing improved ESG ratings as a significant driver of financial gains. The growing demand for these tools has led to increased scrutiny and regulation.

Pietro Bertazzi, Director of Policy & External Affairs at CDP, emphasizes, “It’s absolutely pivotal that the right checks and balances are in place to address this risk wherever possible and ensure capital allocation is efficient and impactful to achieve the goals of global environmental agendas.“

As ESG ratings become integral to financial decision-making, global regulators are implementing policies to ensure their reliability and transparency. The International Organization of Securities Commissions (IOSCO) has provided a framework, recommending oversight, management of conflicts of interest, and transparency in ESG data products.

Since IOSCO’s 2021 report, several jurisdictions, including Japan, Hong Kong, Singapore, the UK, India, and the EU, have developed regulatory frameworks or codes of conduct to govern ESG rating providers. These regulations align with IOSCO’s guidelines but vary in execution, particularly in defining ESG ratings and data products.

Key Regulatory Initiatives:

1. IOSCO Recommendations: IOSCO encourages regulators to ensure oversight of ESG ratings and data products, manage conflicts of interest, and promote transparency. It also suggests that industry standards be developed voluntarily.
2. Global Adoption and Divergence: Eight out of ten IOSCO recommendations have been adopted by major jurisdictions, with some variations. For instance, Japan and the EU have introduced distinct requirements, such as separating rating activities from consulting services.
3. Standardized Definitions Needed: Different definitions of ESG ratings and data products across jurisdictions have led to inconsistencies. IOSCO advises creating standardized definitions to prevent market confusion and enhance policy alignment.

For ESG ratings and data products to support sustainable finance effectively, regulations must be interoperable across borders. Bertazzi states, “Interoperable policies are crucial for this market given that ESG ratings and data products are cross-border assessments, often conducted by providers operating in multiple locations, and consumed by users worldwide.”

Aligning policies globally will reduce compliance costs, improve transparency, and facilitate due diligence processes. As more countries introduce regulations, maintaining consistency with IOSCO’s baseline will be vital for fostering a robust and unified ESG regulatory environment.

Additional Insights from the CDP Report:

• Regulatory Developments: The report highlights the significant evolution in the regulatory landscape, noting that regulators worldwide have been developing both voluntary and mandatory policies to prevent greenwashing and ensure the effective use of ESG data for sustainable investment.
• ESG Ratings Usage: A surge in the use of ESG ratings is noted, with 94% of investors using these tools at least once a month to guide their investment decisions and reduce portfolio impacts.
• Regulatory Frameworks: Various countries have implemented or are in the process of introducing codes of conduct or regulations. The EU, for example, has introduced more ambitious requirements for transparency than those suggested by IOSCO, demanding disclosures about scientific evidence, AI use, and alignment with international agreements.
• Call for Interoperability: The report emphasizes the importance of interoperability among regulations to reduce complexity, lower compliance costs, and ensure a high standard of ESG assessments across borders.

Related Article: 1 in 5 companies report supply chain water risks which could have a significant impact on their business: CDP Report

The evolving regulatory landscape for ESG ratings and data products highlights the need for standardized, transparent, and globally aligned policies. As financial institutions increasingly rely on these tools to meet sustainability goals, regulators must ensure that their frameworks support effective and efficient capital allocation toward a sustainable future. According to esgnews.com