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ESG Ratings Face Uphill Battle, Despite Downgrades

Research finds declining confidence, as the UK opens a consultation on regulating ESG rating agencies.

ESG rating agencies are “at a crossroads”, with research finding discontent and confusion in the market, regulators consulting on tougher rules for the industry and leading provider MSCI preparing to downgrade the ESG ratings of thousands of exchange-traded funds (ETFs).

A recent report, Rate the Raters 2023, published by think tank ERM found investor use of ESG rating products was growing, with 43% of investment professionals saying they were required by their employer to integrate ESG ratings and data into their investment strategies compared with just 12% in 2018/19.

But investor confidence in ESG rating products was moderate. Only 37% said ESG ratings were a credible/quality source of information on corporate ESG performance, although 57% of the same sample said ESG ratings provide information which is material to investment performance.

Speaking to ESG Investor, Aiste Brackley, Partner at ERM, said while ESG ratings had evolved in recent years, many pain points persisted. “Black box rating methodologies and questionable data accuracy are particular concerns,” she said. “Both investors and companies want to see improved quality and disclosure of methodologies and greater comparability across ratings. Until these concerns are addressed, we are unlikely to see greater trust in ESG ratings.”

The report comes as major ESG ratings firm MSCI is set to downgrade 31,000 ETFs from their existing ‘AA’ or ‘AAA’ ESG rating after consultation with clients on changing its methodology. The proposed shake-up will see the number of ETFs with an ‘AAA’ score plummet from 19.1% of the market to just 0.2%, and ‘AA’ from 32.8% to 22.4%, according to an MSCI note. The change in score will reflect MSCI no longer uprating ETFs with more exposure to companies with improved ESG ratings than declining ones, so-called “ESG momentum”.

Brackley said other ESG rating agencies will likely take note and consider whether they should also be making revisions in their own methodology to respond to investor demands and the changing ESG landscape. MSCI was ranked 7 out of 13 by investors in a ranking with other ESG rating agencies, on quality and usefulness in ERM’s survey.

Clarity and consistency

Speaking to ESG Investor, Filippo Addarii, Founder of impact investment consultancy PlusValue, which co-created an Article 8 social fund with Italian asset manager Arca Fondi, said it had issues with ESG rating agencies when using their data and ratings to create the fund.

Addarii said that despite its reputation as the gold standard of ESG data providers, MSCI’s methodology did not help companies and fund managers to understand how their ratings are produced, offering insufficient clarity on company performance across ESG dimensions. This concern is further aggravated by the lack of consistency across ESG data providers. “In some social dimensions we have recorded correlations as low as 0.05 (5%) between providers,” he said.

He continued: “There is simply not enough transparency and scrutiny in the ESG ratings market, and this means that the credibility of sustainable finance as a whole is at stake,” he said, noting that recent collapse of Silicon Valley Bank, stemming partly from inadequate risk management practices, despite its consistently positive ESG ratings.

In a written response, MSCI ESG Research said the firm’s ratings are designed specifically for an ESG integration approach, which uses ratings to support the building of a resilient portfolio for the specific purpose of enhancing long-term risk-adjusted returns.

“MSCI ESG Research makes the full rules-based ESG Ratings methodology publicly available on, with a detailed breakdown of the 35 key issues that can contribute to a company’s rating. Each investor has its own investment objectives and ways of incorporating ESG considerations in its portfolios. Our clients can and do use ESG ratings alongside additional ESG, impact, and climate metrics to inform their decisions and pursue the specific investment objectives and outcomes they desire,” it said.

Innovation and progress

In a recent blog, impact data firm Impact Cubed said ESG ratings overall remained too positive to accurately reflect the ESG performance of companies, resulting in funds containing such firms being highly rated which do not have a net-positive impact.

Speaking to ESG Investor, Chris Lee, Head of Marketing at Impact Cubed, said investors were increasingly taking raw ESG data to create their in-house ESG scores.

Victoria Chartier, Corporate Development Advisor at Paris-based ESG rating house EcoVadis, disagreed, saying investment houses needed external ESG ratings to provide an independent and objective evaluation alongside their in-house ratings.

“Our market experience doesn’t align with the view that ESG ratings are outdated. On the contrary, we are seeing a lot of innovation and progress in the market, both from established and new players. The increasing pressure from investors, public opinion as well as regulators for companies to move towards sustainability practices is in fact a sign that ESG ratings have gained prominence,” she added.

MSCI ESG Research said it takes a precautionary approach as standards for corporate ESG disclosures evolve, penalising companies that do not report quantitative ESG performance data on material ESG issues. “MSCI ESG Research does not treat absence of data as neutral in a company’s overall ESG rating. This approach can help to incentivise companies to publicly disclose material ESG data,” it said.

Last week, the UK government announced a consultation on regulating ESG ratings agencies as part of its new Green Finance Strategy. It includes proposals to force ESG raters to be transparent about their methodologies, governance and processes. The European Securities and Markets Authority (ESMA) has been calling for legislative action on ESG rating agencies since 2021. Japan finalised its code of conduct for ESG data providers in December 2022.

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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