Commercial Ties Influence ESG Ratings: Insights from Moody’s and S&P Acquisitions | Image Source: Www.invasieve-exoten.info
CHICAGO, 21 December 2024 - Recent academic research highlights the important influence of commercial linkages on the reliability of environmental, social and governance ratings (ESGs), particularly in the context of the acquisition of large credit rating agencies (CRAs). The study, conducted by Li, Lou and Zhang, highlighted how the acquisitions of ESG Vigeo Eiris rating agencies for Moody and RobecosAM for S clamp; P led to observable bias in the ESG ratings provided to CRA clients.
Main ESG inflation results
The investigation indicates that following the acquisition of these ESG rating companies by Moody and Slamp, P made a significant upward bias in ESG ratings for its current customers. This bias was more pronounced for businesses with close business ties to the CRAs. According to the study, the ESG scores for CRA clients increased by approximately 17.16% of the standard deviation for the relative ESG scores. These findings suggest that commercial linkages, once limited to credit ratings, have now extended their influence to ESG evaluations.
The study attributes this bias to the conflict of interest effect inherent in the issuer payment model traditionally used by CRAs. The model has long been analysed to encourage agencies in favour of customers in exchange for ongoing business. Although the ESG rating sector remains largely unregulated, the lack of standardisation of ESG measures exacerbates the difficulties in detecting and dealing with rating inflation.
Robust methodology and results
The researchers used a differential regression (DD) model using ESG rating data before and after acquisitions of Vigeo Eiris and RobecosAM. Companies treated – those with a Moody’s or Slamp credit rating; P – showed significant increases in the ESG rating compared to control companies without such links. To ensure robustness, the study standardized the ESG ratings by assessing the consensus ratings of Refinitiv, MSCI and Sustainalytics.
The results of the study were supported by a cross-sectional analysis. Companies with greater transparency in ESG reporting experienced lower rating inflation, while those with long-term institutional investors showed a stronger supervisory effect, mitigating prejudice. This reinforces the idea that transparency and investor supervision play a crucial role in reducing rating distortions.
Broader implications for stakeholders
The research highlights the tangible benefits of inflated GSS ratings for the CRA and its clients. Companies with artificially high ESG securities issued more green bonds and obtained better conditions in financial markets. At the same time, credit rating agencies have retained and attracted credit rating companies by strengthening the reputation of ESG client companies. However, these benefits stem from the cost of reducing the quality of ratings, as indicated by the least information on ESG ratings in forecasting future ESG results.
For regulators and investors, these findings are particularly relevant. The International Organization of Securities Commissions (IOCV) stressed the need to manage conflicts of interest in the ESG rating sector. Similarly, the UK government and the US Securities and Change Commission expressed concern about the integrity of the ESG ratings offered by CRA affiliates.
Request regulatory oversight
With the exponential growth of sustainable investments, the study requires regulatory intervention to ensure the reliability and independence of ESG ratings. Unlike credit ratings, which are governed by strict standards and can be validated by default events, ESG ratings are not verifiable. This difference has led to calls for standardized methodologies and greater transparency in GHG assessments.
The researchers also caution that the current state of the ESG rating industry could lead to further consolidation, reduced competition and possibly increased biases. They advocate policies that strike a balance between innovation in ESM measures and safeguard measures against the undue influence of commercial interests.
As ESG considerations are fundamental to investment decisions, the integrity of ESG ratings will remain a key concern. By highlighting the interaction between business incentives and rating practices, this research contributes to ongoing discussions on the future of sustainable financing and the mechanisms needed to defend its credibility.
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