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Draft ESG Ratings Regulation Could Heighten Investor Costs

European Parliament committee’s plan to boost competition through mandatory selection of providers with less than 15% market share for second rating branded “terrible idea”.

Amends to the EU ESG Ratings Regulation proposed by the Economic and Monetary Affairs Committee (ECON) of the European Parliament could increase costs for users and affect competition, industry experts have warned.  

Boosting competition among ESG rating providers has been a key goal for the committee. If the current proposal is approved, an entity seeking to obtain more than one ESG rating will need to choose at least one rating provider with a market share below 15%. 

Greater competition in the ESG ratings and data provision marketplace should generally lead to the cost of individual providers decreasing. However, under the proposed rule, the overall cost for asset managers or other customers would almost certainly increase, as they would need to pay at least two vendors for data. 

These extra costs could well be passed on to investors and see greater use of larger providers for ratings and data as opposed to smaller ones that can be more expensive for users.  

Rob Furdak, Chief Investment Officer for Responsible Investing at Man Group, described this aspect of ECON’s proposal as a “terrible idea”.  

“We don’t want to be forced to use data from providers that’s not value added,” he explained. “Forcing asset managers to pay a data provider without any clear benefit is just not something we can endorse.”  

Brian Cullen, Chief Commercialisation Officer at Morningstar Sustainalytics, shared a similar view, adding that the new 15% requirement could force investors into selecting rating providers that do not meet their specific needs.  

“Smaller providers are gaining share by innovating or differentiating themselves from established providers, which is the sign of healthy competition,” he said. “Stifling that may make the entire industry less dynamic than it is currently.” 

Rapid regulation driving up costs 

A survey from sustainability firm ERM last year found that 33 investor respondents were spending between US$175,000 and US$360,000 on ESG data and ratings annually, despite having “moderate confidence” in their accuracy and utility. 

The survey also showed that the percentage of investor respondents required by employers to integrate ESG ratings and data into investment processes had increased to 43% in 2022, up from just 12% in 2018-19.  

In addition, 94% of respondents reported using ESG ratings once per month in 2022, up from 78% in 2018-19. The number using them multiple times per week also climbed from 35% to 47% over the same period. Asset managers appeared to be the largest consumers of ESG data. 

“Data in general is very expensive: the more data you use, the more costly it is to run the business,” said Furdak. 

“There aren’t standards in terms of reporting ESG data, so sometimes it’s more costly to source that information, especially across a broad universe of companies.” 

Between 2018 and 2021, the global ESG data market grew by almost 30%. In 2022, it was valued at approximately US$1.3 billion. 

“Some ESG rating providers are charging asset managers very high costs to be able to share information with their clients on why the external vendors’ ratings are good or bad,” said Maria-Elena Drew, Director of Research, Responsible Investing at T Rowe Price. 

A key reason why they can charge such high fees, is the rapid rate at which sustainable finance regulations have been proposed and implemented in recent years. 

“If regulators want to address the cost of ESG data, they should focus on standardising disclosure requirements to a global baseline, like the International Sustainability Standards Board,” Drew added. 

On top of the added cost of having to use multiple vendors, another key element of the ECON proposal was to request providers to consider E, S and G factors separately, in a bid to improve the transparency and integrity of ratings. 

“While this is largely welcome, ESG ratings users will need to spend more to get the complete picture on these disaggregated ratings,” suggested Emily Julier, Senior Knowledge Lawyer on Hogan Lovells’ Sustainability Finance and Investment team. 

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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