Updated with correction: The Institute for Energy Economics and Financial Analysis is based in the U.S.
Japan's early move to govern ESG data and ratings providers is commendable but may be too flexible to address market concerns, an energy finance analyst warned.
Hazel Ilango, an energy finance analyst with the U.S.-based Institute for Energy Economics and Financial Analysis, in a recent commentary commended Japan's Financial Services Agency for finalizing in December a code of conduct for providers of data and ratings.
However, she was more critical that it was designed for voluntary adoption on a "comply or explain" basis that allows the providers to choose not to comply if they can explain why, and to themselves determine the best way to implement the code.
"While not perfect, JFSA's approach takes Japan one step closer to improving the transparency and function of ESG ratings. However, the effectiveness of a voluntary code is yet to be tested in this nascent sector. The regulator's permissive stance over the possibility of diverse ratings results is also questionable," Ms. Ilango said in the commentary.
In the code of conduct, the FSA recognized the wide variety of ESG evaluations and services available, but said "it is not necessarily a problem that evaluation results differ from institution to institution."
But it is a problem, countered Ms. Ilango, whose research shows that the variety of provider methodologies "can result in significant disparities, making them difficult to compare and lacking clarity over how ESG integration affects a security or asset."
Little alignment on definitions and a lack of comparability, transparency or alignment "would inevitably lead to mispricing of stocks and bonds which, in turn, could mean inaccurate inclusion or exclusion of an asset in investment strategies," Ms. Ilango said in the commentary. "These are issues of a flawed ESG rating market that have created divergence and confusion among investors."
ESG data and ratings firms in Japan, including FTSE Russell, MSCI, Sustainalytics, Moody's ESG and ISS ESG, have supported Japan's code of conduct, but "none have explicitly pledged to implement the final code," Ms. Ilango said.
To provide market clarity and standardization, "a unified approach through baseline regulation would enable a common language for all market participants, and a principle-based regulatory intervention could be the way to start," she said.
