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The UK’s financial regulator has warned index providers that they are fuelling greenwashing after identifying “widespread failings” with environment, social and governance benchmarks that guide billions in sustainable investment.
The Financial Conduct Authority said on Monday that the overall quality of ESG-related disclosures made by index providers was “poor” and repeated its determination to ensure that ESG ratings providers should be formally regulated.
“One of our observations was that the subjective nature of ESG factors and how ESG data and ratings are incorporated into benchmark methodologies could increase the risk of poor disclosures,” the FCA said, in a strongly worded letter to chief executives of index providers.
The government is expected to announce a consultation in the near future on whether the FCA remit should be extended to include ESG ratings providers.
“We have previously said that we support regulation of ESG ratings. We are working closely with government on this,” said Jon Relleen, FCA director of infrastructure and exchanges.
Demand for strategies that employ ESG metrics has risen rapidly from both institutional and retail investors, increasing regulatory concerns about greenwashing, where financial product providers make exaggerated or misleading environmental claims.
The limited information given by index providers about ESG metrics and a lack of clarity over how these are applied in the calculation of sustainable investment benchmarks could be contributing to greenwashing, according to the FCA.
This lack of clarity over the application of ESG metrics was “particularly concerning” when it resulted in little material difference between the constituents of ESG indices and similar non-ESG benchmarks, said the FCA.
The City regulator also criticised index providers for failing to implement their own ESG methodologies correctly. It found examples of index providers using outdated ESG data and ratings as well as failures to properly apply exclusion criteria to the constituents of ESG benchmarks.
Lewis Johnston, director of policy at ShareAction, the charity that promotes responsible investment, said: “The FCA is right to zone in on this. We need smarter regulation of the ESG ratings industry to help us tackle the real and significant problem of greenwashing, which undermines not only client and public trust but also the potential of responsible investment to have any meaningful climate and social impact.”
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The FCA’s demand for an improvement in standards was accompanied by a warning that it intended to do more work to “address potential failings” and that the regulator stood ready to take enforcement action which could include issuing financial penalties.
Large index providers, including S&P Global, MSCI and FTSE Russell, have invested heavily in ESG teams that provide data and analytics. Some smaller index providers buy ESG data from specialist third-party providers.
MSCI said that it was “reviewing the FCA’s industry findings, which we will discuss with the FCA as part of our ongoing and regular engagement as an authorised benchmark administrator”.
S&P Global said it was reviewing the FCA’s letter and would continue to engage with the regulator. “We are committed to market transparency and the quality, independent governance and oversight of our indices,” it said.
FTSE Russell, the third-largest index provider, said it published “detailed ground rules and benchmark statements for all benchmarks including ESG, which explain the underlying methodologies. FTSE Russell is fully supportive of and committed to transparency in ESG disclosures.”
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