Code Red: Why an international ESG Code of Conduct and global sustainability reporting standards are needed

• Internationally consistent policy frameworks are key to scaling the market for sustainable finance and investment.
• Alongside global sustainability reporting requirements, the new international Code of Conduct for ESG Ratings and Data Product Providers can help build trust and transparency in the market for ESG ratings, scores and data.
• The Code of Conduct provides a global baseline solution which jurisdictions can leverage to bring about more consistency in the oversight of this market.

The scale of institutional investor usage of environmental, social and governance (ESG) ratings, scores and data has grown rapidly from niche beginnings. On a global basis, these investors are increasingly integrating ESG considerations into investment strategies and across portfolios. LSEG’s annual survey of asset owners found in 2018 that 53% of respondents were integrating ESG into their investments. In our most recent survey, with over 350 asset owners taking part, the share has increased to over 80% globally.

As market usage of ESG ratings and other sustainability information has grown, so have concerns over quality, consistency, accuracy and transparency. One common issue raised is the limited correlation between ESG ratings for the same companies (see Aggregate Confusion), which can be explained by the different methodologies and varying data inputs that go into these assessments, including different conceptions of materiality (see LSEG’s research). The underlying information that forms a core backbone for ESG ratings is corporate reported data, but sustainability disclosures remain patchy and inconsistent. As a result, commercial data providers have to either treat poor disclosure as poor performance, or estimate and model the missing information – and, as LSEG’s research shows, these estimates can vary significantly depending on the approach used.

Even where companies do report sustainability information, the use of different reporting structures and norms can lead to incomparability between peers. Global standards and mandatory reporting can help solve these challenges. However, there are also important questions on transparency of methodologies, perceptions of greenwashing and conflicts of interest management.

Naturally, the growing use of ESG data and the debate over market standards has caught the attention of policymakers and regulators. In 2021, the International Organization of Securities Commissions (IOSCO) published recommendations on ESG data and ratings oversight. Since then, a range of jurisdictions have taken forward related policy initiatives^[1].

Importantly, some of these initiatives draw heavily on IOSCO’s recommendations. Doing so helps to prevent fragmentation in Codes of Conduct and regulations across jurisdictions, which could otherwise lead to confusion in the market and potentially create scope for greenwashing. For example, a lack of consistency with IOSCO’s definition of an ESG rating could lead to providers of these products being subject to different levels of requirements for the same product, from one jurisdiction to another, ultimately undermining global transparency efforts.

To promote international consistency further, there has been an effort in the UK during the past year to develop a Code of Conduct that is entirely in line with IOSCO’s recommendations. In 2022, the UK Financial Conduct Authority (FCA) appointed the International Regulatory Strategy Group and International Capital Market Association (ICMA) to convene an industry group tasked with developing a globally consistent voluntary Code of Conduct for ESG Ratings and Data Products Providers^[2]. After over a year of development, ICMA published the Code of Conduct in December 2023, with a formal launch at LSEG’s headquarters on 31 January 2024. While it originated in the UK, the Code is intended to be used internationally, and accordingly will be owned and run by ICMA.

The Code of Conduct puts forward six best practice principles, which are based on and fully aligned with IOSCO’s recommendations, promoting global consistency in policy frameworks for ESG ratings and data. The Code offers an “off-the-shelf” baseline solution that jurisdictions considering their own Codes of Conduct can adopt. By providing a common global framework, the Code can also help to support equivalence and deference regimes in the future that would enable cross-market compliance and minimise the costs of following multiple frameworks across jurisdictions. This would help to reduce costs for new entrants looking to sell products internationally. It would also help to avoid providers opting out of countries due to compliance costs, ultimately reducing choice for consumers.

While Codes of Conduct for ESG data and ratings are a welcome step, the key to enhancing trust and transparency in the market is improving the underlying data that goes into ESG assessments. LSEG’s 2022 research showed that over 40% of the FTSE All World index (about 3,900 large and mid-caps globally) were still not disclosing basic Scope 1 and 2 emissions. In 2023, the international community made considerable strides towards addressing this challenge – not least with the launch of the International Sustainability Standards Board’s (ISSB) inaugural Sustainability Disclosure Standards in June. Alongside the Principles for Responsible Investment, LSEG has been calling for the global adoption of the ISSB standards on an economy-wide basis by 2025. Adoption would dramatically improve the consistency and quality of sustainability-related data to inform ESG assessments.

Markets function more effectively with consistent global policy interventions that enhance and scale finance and investment. This sector faces fragmentation challenges again and again, from fund labelling to sustainability reporting and, of course, oversight regimes for ESG data and ratings providers. Market participants, policymakers and other global stakeholders should continue to work across jurisdictions to advance global standards, enabling capital markets to address sustainability challenges.

1. Examples of ESG data policy initiatives include: European Union Regulation on ESG Rating Activities – proposed by the European Commission and currently under legislative scrutiny; UK Future Regulatory Regime for ESG Ratings Providers – consultation closed with next steps to be determined; Japan Code of Conduct for ESG Evaluation and Data Providers – issued by the Financial Services Agency of Japan and in implementation phase; Singapore Code of Conduct for ESG Rating and Data Product Providers –  developed by the Monetary Authority of Singapore  for implementation in 2024; Hong Kong ESG Ratings Code of Conduct – under development by working group led by ICMA; Securities and Exchange Board of India (SEBI) Regulations for ESG Rating Providers – in implementation phase.

2. The ESG Data and Ratings Code of Conduct Working Group (DRWG) was co-chaired by a Steering Committee consisting of Moody’s, M&G, Slaughter and May, and LSEG. The DRWG brought together international stakeholders such as ratings and data providers, asset managers, asset owners, banks, corporate rated entities, NGOs, academics and other organisations. The FCA, HM Treasury and other national and international financial regulators acted as observers as the Code was agreed.