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Magazine Issues » November 2022

Association Column: Efama calls for ESG ratings regulation

RegulationEurope’s pan-European asset management body urged the European Commission in October to develop a regulatory framework for funds carrying high ESG ratings, Funds Europe’s Nick Fitzpatrick reports.

With fund advisers and distributors likely to create a higher need for ESG ratings during the ‘green transition’, the European Fund and Asset Management Association (Efama) has called on the European Commission to regulate the ESG ratings market.

Efama studied more than 15,000 funds with ESG ratings from Refinitiv and Morningstar, two ESG ratings providers. The funds are categorised either ‘Article 8’ or ‘Article 9’ according to the strength of their ESG capability under the EU’s Sustainable Finance Disclosure Regulation (SFDR).

Efama researched 9,315 Refinitiv ESG-labelled funds valued at €4.3 trillion (as of August 2022) and 6,250 Morningstar-rated products worth €3.3 trillion in the same month.

The average Refinitiv ESG scores for Article 9 funds are slightly higher than those for Article 8 funds, Efama said. However, the differences are “quite small”, with a large group of Article 8 funds carrying relatively high ESG scores, whereas some Article 9 funds had low scores.

Morningstar sustainability ratings showed the majority (54%) of Article 8 funds scored higher than average in their ESG risk management. For Article 9 funds, that figure is higher at 71%. However, 7% of Article 9 funds were ranked as below average.

There was a fairly small positive correlation between the providers’ ESG ratings. Many funds with a low Refinitiv score do well in the Morningstar ratings, and vice versa. This is not too surprising, said Efama, because ratings are based on a provider’s own proprietary assessment that bears “little relationship” with the SFDR classification.

Tanguy van de Werve, director general at Efama, said: “Use of ESG ratings for funds is expected to grow rapidly as investor demand for ESG funds keeps increasing. Therefore, it is important that the market for ESG ratings functions well, with proper disclosure of decision-useful information.”

Policy recommendations
An EU regulatory framework for ESG ratings should have three main objectives, according to Efama.

First, the framework should impose disclosure of the methodologies and data sources used to provide ESG ratings. Secondly, the framework should also provide a level playing field by ensuring that all major firms assigning ratings to funds domiciled in the EU are within scope, including non-EU providers generating a certain percentage of EU revenues.

The third point is that market integrity should be preserved by setting specific requirements for internal controls and governance processes to avoid conflicts of interest.

Efama also said supervisory authorities should look to prevent excessively high fees for ratings services by gaining a good understanding of the pricing and licensing frameworks involved so that regulators can ensure a competitive market.

A voluntary code of conduct could be developed in the meantime, said the trade body, to provide valuable insight for the future legal framework.

Vera Jotanovic, senior economist at Efama, said: “From our analysis, we conclude that different ESG scoring/rating methodologies have different measurement objectives, which are not necessarily in line with the SFDR classification or investors’ ESG preferences. Thus, these ESG measures should not be relied upon in isolation when advising retail investors.”

Bernard Delbecque, senior director for economics and research at the trade body, said the benefit of transparency in the methodology used by ESG ratings providers is that advisers and distributors should be able to rely on the providers “whose measures most closely align with the investor’s ESG preferences”.

Efama also said that Article 8 or 9 status, as well as ESG ratings, should not be used in isolation.

To understand the ESG characteristics of a fund, advisers and distributors should use additional tools, including the European ESG Template (EET), and national/international guidance.

Efama warned against only using Article 9 funds for clients expressing strong ESG preferences. What advisers and distributors need to do is verify if a fund’s ESG approach is aligned with the investor’s ESG preferences and views on risk.

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