Britain should regulate sustainability ratings on companies to improve transparency, reduce the risk of greenwashing and protect investors, a regulatory research body said on Monday.

The wall of money going into environmental, social and governance (ESG) funds has raised concerns among regulators about greenwashing, when sustainability credentials are exaggerated to attract investor cash.

The International Regulatory Strategy Group (IRSG) said in a report that the use of ratings was growing fast and investors needed confidence that the market was operating with a high degree of integrity.

“While ESG ratings provide just one interpretation of the many sources of ESG data available to portfolio managers, the growing significance of ESG ratings products across both equity and fixed-income markets cannot be understated,” the IRSG said.

At the moment, asset managers typically use largely unregulated ratings on a company’s ESG credentials to pick stocks on behalf of investors and pension funds.

The IRSG, sponsored by TheCityUK and the City of London Corporation, called for a principles-based and proportionate set of rules which dovetail with global efforts to bring consistency and standardisation to data and protect investors.

“The IRSG believes that regulation of ESG ratings is now desirable, to provide more transparency around the basis for ESG ratings and mitigate against potential conduct risk,” it said.

Britain’s Financial Conduct Authority consulted last year on whether there should be voluntary “best practice” guidance for ESG raters or binding regulation, with the outcome due this year.

The European Union’s securities watchdog, ESMA, is also studying the sector ahead of potential EU regulation, while global securities body IOSCO set out its first global framework last November to prise open the “black box” of ESG ratings.

The IRSG said a global approach was needed to avoid fragmentation in rules which would bump up compliance costs.

“Increased efforts are required to improve the quality, consistency, and availability of the underlying data to ensure market confidence in ESG products,” said the report produced with consultants Accenture.

Source: Reuters