5.9 Conclusion

As discussed above, all the market participants involved in the ratings market, in particular, the companies, investors and the raters (e.g. sustainability indices and rating agencies) depend on each other. Increased engagement would possibly be in their benefit, as the alignment of their common interests may contribute to working together to address the most pressing challenges in a more coordinated and beneficial way.1 Engagement seems important for exploring new ways for cooperation, to understand the needs of companies and investors, on identifying material ESG risks, and to find the ways in which the raters can help providing the information (through new products and services) they need in real-time.2

Briefly looking at the history of credit rating agencies, we could identify five potential problems credit rating agencies may face that sustainability rating agencies may also have to deal with. The first is related to the independence of rating agencies and the integrity of the rating process, which can be compromised by potential conflicts of interest. Less Governmental intervention in the past of credit rating agencies may also contribute to increasing credibility and better quality sustainability ratings. The second problem credit rating agencies may face is how to avoid a monopolistic credit ratings’ market. This problem may become more challenging with the possibility of creating Nationally Recognized Statistical Ratings Organizations (NRSROs). Third is managing the lack of ratings accuracy, which could benefit from increased completion and would favor the investors.Fourth is the “subscriber pays” model and the “free-rider” problem, which has been used by credit rating agencies, and with the support of the regulator may also benefit sustainability ratings. Fifth, managing the lack of factual verification which could be overcome by hiring independent experts (Coffee, 2014 pp. and 266, 267) and with increased Governmental oversight on rating agencies business operations.

Both credit rating agencies and sustainability rating agencies are needed in the financial market. Credit rating agencies increase investor’s trust on the creditworthiness of issuers and reduce uncertainty (Coffee, 2014).3 Sustainability rating agencies complement the credit rating agencies’ work by increasing investors’ trust on the issuers’ ESG performance.

Market standards are still evolving. More education and awareness on the long- term benefits of increased ESG disclosure and performance ratings could probably be beneficial for the long-term development of this area. I have introduced five challenges in the sustainability ratings’ industry. First, a one-size-fits-all approach does not seem to be as beneficial as the ratings per industry, sector and size. Engagement, through e.g. dialogue, will bring more clarity to the market participants’ needs and facilitate the response to challenges. Second, the multiplicity of ESG ratings and research providers also triggers investors’ additional information requests to companies. Third, another consequence of the multiplicity of ESG ratings and research providers is the multiplication of information requests and the duplication of information, which is a burden to companies and also to investors.Fourth, managing insufficient information and publishing insufficient information; transparent methodologies, criteria and policies can bring trust to the ratings’ provider and credibility to its products and services. Finally, the fifth, is the successful management of conflicts of interest, which influences how raters keep their independence and avoid being on the spotlight for the wrong reasons, as we saw with the past financial crises.4

Involvement of the Government and market regulators in the process of mainstreaming of accurate, reliable and real-time rating principles could prove beneficial for accelerating the process. As we have seen in chapter 2 with the mainstreaming of IFRS, the involvement of the European Commission and national Governments may have increased compliance and enforcement. There are over 100 raters in the market who developed their own methodologies and often, rate the same issues. Companies and investors are challenged to select which raters and information to trust. It seems that the answer may not be to develop a new rating standard but instead focus on a standard to rate the raters, which The GISR is trying to achieve. The GISR works towards developing rating principles for the raters. The idea of focusing on the raters and not just on the rated looks promising. Just as we saw with financial reporting, all auditors and credit rating agencies are bound by the same rules to audit and rate, respectively.5 It seems logic to have an independent organization focusing on the rater’s performance. External assurance of the data provided by ESG research providers using standards as the Arista 3.0 is also considered to increase credibility in the data provided and in ratings.

Looking at the successful business cases in Brazil, with B3, former BM&FBOVESPA, and in the US with the DJSI (see chapter 3), but also in other parts of the world as in South Africa, with the Johannesburg Stock Exchange, we see the influence of positive regulatory change, through the support of the Governments. Companies are more likely to report specific information if such disclosure is made mandatory by a stock exchange or regulator (UNCTAD, 2011; Ioannou and Serafeim, 2012). If there would be more clarity and more robust evidence about the link between financial returns and ESG disclosure, stock exchanges could have a financial incentive to change their listing requirements and include ESG listing requirements. Otherwise, mostly Government regulations and political support would drive interest in the field.

There is a long way between commitment to initiatives as the UN-supported Principles for Responsible Investment and effective implementation, however, the increasing number of signatories of responsible investment’ initiatives, the number of ESG assets under management and the increasing use of ratings as an investment tool, point towards the direction of growth of the responsible investment trend, as ratings became an increasingly used tool amongst investors. Consequently, there will be room for further innovation, in particular in personalized sustainability indices that meet their investment objectives.6

There are great expectations in the recent developments of the green bond market, such as the EU’s Technical Expert Group (TEG)’ recommendation to develop a voluntary EU green bond standard. It looks like it is moving beyond the market’s current early formative stage as it has reached a level of size and maturity, there can be a basis for further improvements. Improvements in the development of green bonds indices can attract attention from investors and contribute to enhancing the benefits of environmental friendly projects. Green bonds are not yet an asset class but have the potential to become one.7

The developments referred in this chapter highlight the potential of enhanced ESG disclosure and performance ratings to contribute to mainstreaming sustainability reporting practices and ultimately, to encourage changes in business culture and practice. Also following on the recent EU Action Plan of 2018, the European Securities and Markets Authority (ESMA) has launched a consultation paper, proposing that in the future credit rating agencies may be required to disclose whether and how ESG criteria have been considered as part of a credit assessment outlook.8 This is based on the fact that companies are increasingly integrating ESG risks in their annual reports and non-financial information becomes more quantifiable.

As the Global Initiative for Sustainability Ratings (GISR) well explains it, the goal is to put the principle of the information value chain in practice (see Figure 1, above in section 5), where all the market participants in the rating process add value to each other’s work and add value to capital markets, to society and to the environment.

Disclaimer: Industry Leaders are based on the September score calculation. As per its Media & Stakeholder Analysis process, RobecoSAM may make periodic adjustments to company scores, rankings and index inclusion.

*No industry leader selected. No company in the Diversified Consumer Services industry has been selected as a constituent of the DJSI as a result of not meeting the minimum eligible score requirements.

Source: RobecoSAM10