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U.S. markets regulator flags risks for ratings firms in ESG boom

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U.S. markets regulator flags risks for ratings firms in ESG boom

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Credit ratings agencies face new risks as they throw themselves into the fast-growing business of environmental, social and governance (ESG)-based investing, the U.S. Securities and Exchange Commission (SEC) warned in a new report.

Investors have poured record amounts of money into funds that use ESG criteria to select holdings, leading to the rise of ratings services aimed at guiding those investments.

That creates new potential risks for the ratings agencies, such as failing to follow ratings methodologies and failure to manage conflicts of interest, the SEC said, issues that have dogged the industry since the 2008 financial crisis.

DBRS Inc, Fitch Ratings, Kroll Bond Rating Agency Inc and S&P Global Ratings are among the firms overseen by the SEC.

The SEC’s 2021 report, which is based on exams of ratings firms, said that by adding ESG factors, ratings firms may deviate from their usual methodologies, policies or procedures which may not be properly disclosed to investors, the SEC said.

Adding ESG ratings also raises the risks of new conflicts of interest if firms feel pressure to give higher ESG ratings than warranted when the subject is also a client, the SEC said.

Transparency and consistency of ESG investment ratings have faced increasing scrutiny to help combat so-called “greenwashing.” Often ratings can be at odds with each other as analysts assigned different scores to issues like emissions, workers’ pay or composition of company workforces.

The SEC is developing new rules for disclosing information on ESG issues including climate change risks and workforce composition.

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