Last week the International Organisation of Securities Commissions Organisation (IOSCO), a global association of regulatory agencies for securities, reiterated their support for developing a global framework for sustainability standards. In a recent media release, they recognised the need for “globally consistent, comparable, and reliable sustainability disclosure standards” and introduced their plan to develop a Sustainability Standards Board (SSB) under the International Financial Reporting Standards (IFRS) Foundation. Over the past year a Sustainable Finance Task Force (STF) has been investigating disclosures from security issuers and asset managers, along with information on ESG data and ratings. They found that investors have excess demand for sustainability related data, and that firms often only selectively released such information. As financial markets heavily rely on fast and accurate information disclosure, the IOSCO board decided a change is needed.
Demand for sustainable investment solutions is ever increasing, and consequently so is the need for information on Environmental, Social and Governance (ESG) criteria. However, a frequently discussed problem in this market is the lack of agreement and inconsistency among third-party rating agencies about what constitutes a sustainable asset. Before the idea of a SSB, there has been no cohesive international standard, making those firms with high ratings more credible than perhaps they should be. SustainAbility, a think tank and advisory firm, have published a ‘Rate the Raters’ document over the last decade, gathering information on the discrepancies between the 600+ rating agencies in the industry. In the 2020 report, they found that 65% of the investors they surveyed used ESG ratings at least weekly, but rather than using the scores themselves the primary focus was on the data behind them. When interviewed by SustainAbility, many investors claimed to use this data to do their own research as the ratings are “fraught with issues” and inaccurate.
A 2019 study by MIT, called ‘Aggregate Confusion: The Divergence of ESG ratings’ found that the correlation between the ratings of the top 6 agencies was only 0.61. This is very weak compared to the correlation of credit ratings from Moody’s and Standard & Poor’s, for example, which MIT found to be 0.99. This problem was foregrounded in 2020 when fast-fashion retailer, Boohoo, received an AA rating from one of the largest ESG rating providers, Morgan Stanley Capital International (MSCI). This was despite allegations that UK workers for the company were only receiving an hourly pay of 3.50 GBP, which is below the minimum wage. Furthermore, the fast fashion industry itself is very damaging to the environment, with the World Economic Forum finding fashion responsible for 10% of carbon emissions and 20% of industrial water pollution globally in 2020. Consequently, Boohoo’s role as a fast-fashion producer seems contradictory to such a strong ESG rating. This emphasises investors’ difficulty in determining the reliability of ESG ratings which potentially influence their investments.
ISOCO’s former secretary-general, Paul Andrews, highlighted the challenges of comparing ESG disclosures because of the lack of “common definition of what a sustainable finance product is.” This creates a degree of subjectivity, permitting the firms to choose which factors and risks they want to communicate to investors. This sentiment of frustration at the lack of clarity was echoed in many markets. One example is Vitaly Nesis, who is the chief executive of Polymetal, the biggest gold producer listed in London. Last October, he told the Financial Times that “rating agencies frequently lack a robust analytical framework” and they just “tick the boxes” when rating ESG performances in the mining sector.
IOSCO’s involvement in the development of the SSB aims to create a “strong governance foundation” where they create a widely accepted baseline level of disclosure from firms, whilst being consistent with accounting reporting standards that are already in place. IOSCO claim that their role as a membership organisation of the world’s securities regulators makes them an essential part of an institution such as the SSB, because of their international scope. Furthermore, the members of the organisation are responsible for regulating over 95% of the world’s securities markets, so if successful the SSB could have a very extensive impact.
Benefits of a board such as the SSB would include an increase in transparency for investors, and a reduction in greenwashing, where businesses convey themselves to be more environmentally proactive than they truly are. These changes should encourage investor confidence. Furthermore, if successful, it would provide a basis for the future development of mandatory reporting from firms. The concept has been well received by stakeholders, such as investors, regulators and existing standards bodies. In a recent report, IOSCO also commented on their ‘climate first approach’ and see a need to focus on reporting standards relating to climate change in the near future. It is suggested that the creation of the SSB will be announced at the United Nations Climate Change Conference in November this year. If successful it could prove very beneficial in providing clarity and agreement on ESG standards and performance.
By Beth Pittman
Sector Head: Sophia Li