MSCI Ratings Overhaul Spells Uncertain Future for ESG ETFs

Funds may cut use of environmental, social and governance label, expert says.

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Reviewed by: Shubham Saharan
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The launch of environmental, social and governance exchange-traded funds may slow, or the label may be dropped altogether, as one of the primary ETF research firms prepares to cut its ratings on thousands of funds, industry experts say.  

MSCI, an index provider that also grades ETFs based on their compliance with ESG standards, is ready 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 three-quarters of funds evaluated by MSCI included a “positive adjustment factor,” the release said.  

The changes come in response to feedback from market participants, the release reads, 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 firm has said.  

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

Last June, the SEC issued a request for comment to gauge the need to impose tougher standards on providers such as S&P Global, MSCI and FTSE Russell, who provide underlying indexes 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, wrote in emailed comments to etf.com.  

“An increase of scrutiny in the ESG and sustainable-related investment area is needed,” she 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,” Gregson added.  

 

Contact Shubham Saharanat[email protected] 

Shubham Saharan is a markets reporter at etf.com. Before joining the company, she reported for Bloomberg and the Financial Times. Saharan is a graduate of Barnard College of Columbia University.