Japan to ramp up scrutiny of ESG data providers with new guidelines

Japan will soon be the first country to issue guidelines for ESG data and ratings providers as global regulators step up scrutiny of firms that measure companies on their environmental, social and governance practices.

The Financial Services Agency is finalizing its draft code of conduct this month after receiving industry feedback, the regulator said. The draft guidelines, first published in July, outline voluntary principles to ensure the quality of the data and processes backing these ratings.

"We hope that the code of conduct will improve the transparency and fairness of ESG data and assessment services, as well as the development of the ESG market," Hideki Takada, director for strategy development at the FSA, said in an interview.

With ESG assets set to reach $53 trillion by 2025, concerns are growing over the substantial influence these typically unregulated ESG data providers have over the industry. The International Organization of Securities Commissions warned last year that the lack of standards could result in risks including greenwashing and misallocation of assets. Japan's draft code is based on recommendations from the securities group.

Singapore and the U.K. are exploring similar guidelines, while the EU's financial markets and services commissioner, Mairead McGuinness, reiterated concerns about the lack of transparency and consistency within the ESG ratings industry. Following a recent consultation process, the EU is now "considering a proposal to bring more transparency to the market and introduce rules on ESG rating agencies' operations," she told lawmakers on Monday.

Japan's approach "emphasizes flexibility rather than obligation," Mr. Takada said. "The issue of how far we can guarantee its effectiveness may emerge in the future, but we would like to first look at voluntary changes in the market and then consider whether further action is necessary."

ESG scores can be problematic for investors because they're largely based on self-reported and unaudited data from companies. Varying methodologies among ratings providers can also result in big discrepancies.

Sustainalytics and Institutional Shareholder Services, two of the biggest providers of ESG data and ratings, said they supported the FSA's flexible, principles-based approach, as well as its alignment with IOSCO's recommendations.

However, the firms raised concerns about the scope of the guidelines, which they say ought to focus on ESG ratings, not data products.

"We do not see a public policy justification for raising unique scrutiny of ESG data," ISS wrote in its feedback email to the FSA. "ESG data should be treated on a level regulatory playing field relative to 'traditional' financial data and its providers."

Sustainalytics, a unit of Morningstar, said the code may be hard to implement, "leading firms to opt out of the voluntary standard, at least to the extent it applies to data."

MSCI, another data provider, declined to comment to Bloomberg.

Bloomberg News parent Bloomberg LP also provides ESG data and ratings.