ESG Ratings: A Blind Spot for U.S. Securities Regulation

Alexander Coley | January 1, 2022

Providers of “Environmental, Social, and Governance” (ESG) ratings have emerged as prominent informational intermediaries in the sustainable finance ecosystem. The key players are familiar names such as Moody’s, Morningstar, MSCI and S&P. In recent years, investors, financial markets observers and academics have raised serious doubts about the value and integrity of ESG ratings, pointing to lack of reliability and comparability and risks of conflicts of interest and abuse, including the potential for “greenwashing.” ESG ratings are now in the crosshairs of financial regulators, particularly, in Europe. However, the regulatory discourse has failed to contend with risks arising from the use of ESG ratings by companies (issuers) in their public disclosure – for example, to advertise their ESG bona fides on earnings calls, in road show materials for securities offerings, or even committing to the maintenance, or improvement, of ESG ratings in promises to investors. Drawing on use cases of green bonds and other sustainable finance instruments, the paper argues that although ESG ratings have become deeply intertwined in the securities offering process, they are effectively insulated from securities law liability. To make this argument, the paper highlights a structural similarity to the SEC’s attempt to regulate the use of credit ratings in the wake of the global financial crisis – an effort which has been criticized as toothless. If the treatment of credit ratings under U.S. securities law is any guide, there is little reason to expect that ESG ratings will serve as the basis for liability, no matter how much importance investors attach to them. This conclusion has broader ramifications for understanding the contours of Section 11 liability for third-party experts. More immediately, the paper should inform ongoing efforts by the SEC and other financial regulators to map out and address new sources of risks building in the sustainable finance market.