MSCI ratings overhaul spells uncertain future for ESG ETFs

Many ESG ETFs are set to be downgraded in MSCI's updated ratings

Shubham Saharan

a glass on a mossy rock

The launch of ESG ETFs may slow, or the label may be dropped altogether, as MSCI prepares to cut its ratings on thousands of funds, industry experts have said.

MSCI, an index provider that also grades ETFs based on their compliance with ESG standards, is set to lower nearly 31,000 funds’ ESG scores as it tightens up the criteria’s meaning.

The changes involve a new method of ESG score computing, which removes so-called adjustment factors that have previously buoyed ratings in the past, according to an MSCI statement.

By the end of last year, nearly 75% of funds evaluated by MSCI included a “positive adjustment factor,” the release said.

The changes come in response to feedback from market participants, MSCI said, as “these enhancements were intended to address issues that clients had raised, most notably an upward drift in ratings across the fund universe”.

The updated methodology would slash the number of funds with the top AAA ESG rating. The changes, set to take effect by the end of this month, may mean that 0.2% of ESG ETFs would have AAA ratings, compared to the almost 20% which hold them currently, the index provider said.

The changes follow backlash directed at data providers like MSCI, whose standards have been criticized as inconsistent and unregulated.

Last June, the Securities and Exchange Commission (SEC) issued a request for comment to gauge the need to impose tougher standards on providers such as S&P Dow Jones Indices, MSCI and FTSE Russell, which provide underlying indices for many ETFs.

The SEC has also proposed requiring more disclosures about investments in companies that say they adhere to ESG factors. A final version of the rules is expected later this year.

While the changes are being welcomed by the ETF industry, they may cause name changes and a slowdown of product releases, Lois Gregson, senior ETF analyst at data provider FactSet, told ETF Stream's sister publication

“An increase of scrutiny in the ESG and sustainable-related investment area is needed,” Gregson said. “Initially, I believe we will see a lot of fund name changes, dropping the use of ESG or sustainable reference, for funds not meeting the higher rating requirements.

“We will see new funds launch but at a slower pace.”

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