From Fiduciary Duty to Duopoly: Making Sense of ESG Ratings in 2025

The Fraser Institute’s new report warns that ESG ratings are ‘a lawsuit waiting to happen’. The phrase makes for a striking headline, tapping into wider anxieties about sustainability investing. Yet this framing potentially misrepresents both the legal foundation and the actual function of ESG ratings in finance today. The lawsuit narrative creates compelling copy and speaks to broader cultural tensions around ESG and sustainability investing. However, this approach misses the deeper story about how financial risk assessment is evolving and why that evolution matters for investors, regulators, and companies navigating an increasingly complex landscape.

Fiduciary Duty is Settled Law

The legal foundation deserves examination first. Paul Watchman’s groundbreaking Freshfields report from 2005 established that ESG considerations can - and sometimes must - be integrated where they are financially material. This represents settled law rather than radical interpretation. The Fraser report leans heavily on Cowan v Scargill, though that 1985 case is often misused in these debates. The ruling did not create a blanket prohibition on ESG considerations. Rather, the decision established that trustees cannot sacrifice financial returns for purely ethical goals. That question differs entirely from whether environmental, social, and governance factors can affect long-term financial performance.

Twenty years of subsequent case law and regulatory guidance have clarified this distinction. This point was settled two decades ago. The real debate concerns how ESG factors are assessed, not whether they can be considered. Fiduciary duty does not block ESG integration where material risks are identified. What the law prohibits is the subordination of beneficiary interests to other objectives. Understanding this distinction proves essential for evaluating current criticisms of ESG ratings and their use in investment decision-making.

What ESG Ratings Actually Are

This distinction leads to a fundamental misunderstanding that runs through much criticism of ESG ratings. Henry Fernandez, CEO of MSCI, has been clear about what his company’s ratings measure: ‘a company’s resilience to financially material environmental, social and governance risks’. They are not, he emphasises, ‘a general measure of corporate “goodness”, a barometer on any single issue or synonym for sustainable investing’. This clarification matters enormously because ESG ratings function as risk tools rather than virtue scorecards. They assess how well companies manage exposures that could affect future cash flows - regulatory shifts, supply chain disruptions, talent retention challenges, governance failures. The confusion arises because many retail investors and even some financial professionals conflate ESG integration with impact investing or values-based screening.

These approaches represent fundamentally different investment philosophies. ESG integration asks whether sustainability factors are financially material to investment returns. Impact investing asks whether investments can generate measurable environmental or social benefits alongside financial returns. Values-based investing excludes certain sectors or companies based on moral criteria rather than financial considerations. The Fraser Institute’s critique conflates all three approaches, which muddies the analysis considerably and mischaracterises what most institutional investors actually do when they incorporate ESG ratings into their decision-making processes.

The Origins and Intent of ESG

Understanding where ESG came from helps clarify what the framework was designed to accomplish. Paul Clements-Hunt, who helped create the original UN Principles for Responsible Investment, described ESG as essentially ‘a guerrilla operation’. The terminology was deliberately chosen to sound business-friendly while creating space for long-term thinking about factors that traditional financial analysis often missed. In his 2024 foreword to my book, Clements-Hunt put the matter bluntly: ‘Is ESG perfect? No. Is it sustainability? No. Rather, ESG functions as a signal that risk is changing’. The framework emerged from recognition that environmental and social trends - climate change, demographic shifts, technological disruption - create financial risks that markets were not pricing effectively.

This history matters because the origins rebut the idea that ESG is inherently ideological or political in nature. The framework developed from practical recognition that long-term value creation requires attention to factors beyond traditional financial metrics. Whether investors care about these issues morally remains irrelevant to whether they affect investment returns over time. The terminology succeeded precisely because it allowed fiduciary-bound institutional investors to consider sustainability factors within their existing legal obligations rather than requiring them to subordinate beneficiary interests to broader social goals.

Industry Structure: Duopoly but Not Alone

As I argued in ESG Rating Agencies and Financial Regulation (Edward Elgar, 2024), describing an ‘ESG ratings industry’ proves misleading. What exists is effectively a duopoly dominated by MSCI and S&P Global, whose vertically integrated business models tie ratings to index licensing. MSCI alone has $16.9 trillion in assets benchmarked to its equity indexes. S&P’s Corporate Sustainability Assessment feeds directly into its index construction processes. This concentration creates real problems for market competition and innovation. When two firms control the intellectual property underlying the most widely used financial benchmarks, their methodological choices have outsized market impact. The EU’s new regulation on ESG ratings tackles this concentration directly by requiring separation of business activities - preventing ratings providers from also selling the indices that use those ratings. However, this will likely be easy to work around.

The story extends beyond the duopoly, however. Hundreds of smaller providers offer specialised methodologies, regional expertise, and alternative approaches to sustainability assessment. These firms - from Sustainalytics to ISS to countless boutique providers - bring diversity to the ecosystem. They often focus on specific sectors, geographies, or sustainability issues that the giants overlook or treat superficially. The challenge for smaller providers involves more than competing with MSCI and S&P’s resources. They face the structural disadvantage of vertical integration, where rating methodologies feed directly into widely-used benchmarks, creating a self-reinforcing cycle that proves difficult to break. Regulation is now addressing this imbalance thoughtfully, creating space for innovation while imposing accountability standards across the entire market. Whether it affects the duopolistic structure that has revealed itself in the ESG rating ‘industry’ we wait to see.

Divergence Critiques: The Right Way to See Them

Much criticism of ESG ratings focuses on divergence - the fact that different providers often rate the same company very differently. This criticism has been repeated for over a decade, though it usually ignores the fact that divergence reflects different lenses rather than methodological errors. The Fraser Institute treats this divergence as evidence that ratings are meaningless. However, divergence can represent a feature of the system rather than a flaw that needs correction. Credit ratings converge because they measure essentially the same thing: probability of default over specific time horizons. ESG ratings diverge because they measure different aspects of sustainability performance using different methodologies, time horizons, and materiality judgments. One provider might weight climate risks heavily; another might focus on labour practices; a third might emphasise governance structures. Admittedly there are instances where different providers consider the same thing differently, which was analysed in the Aggregate Confusion research project, but this will naturally decline as the ‘industry’ continues to converge.

This diversity more likely reflects genuine intellectual disagreement about what matters most for long-term value creation rather than confusion or incompetence. Rather than demanding artificial convergence, regulation is moving toward requiring transparency about these differences. The EU’s new rules mandate disclosure of methodologies and clarification of whether ratings address single materiality (risks to the company) or double materiality (company impacts on society and environment). The UK’s approach goes further, creating explicit labels that signal investment intent: Sustainability Focus for assets that are currently sustainable, Sustainability Improvers for transition strategies, Sustainability Impact for solutions to sustainability problems. This framework acknowledges that different investors have different objectives and should not be forced into a one-size-fits-all approach to sustainability assessment.

The Real Risk

The genuine problem with ESG ratings involves public confusion rather than lawsuit liability. When retail investors think they are buying virtue while actually receiving risk tools, disappointment becomes inevitable. When companies spend hundreds of thousands of dollars chasing ratings that measure different things in different ways, resources get wasted without clear benefit. The solution does not require abandoning ESG ratings entirely. Rather, the market needs professionalisation through better disclosure and clearer communication about what these tools actually measure and how they should be used in investment decision-making.

Both EU and UK regulations are pushing in this direction, requiring providers to explain what they measure and how they measure it. This transparency will not eliminate all confusion immediately, though it should help sophisticated users - pension funds, asset managers, institutional investors - make better decisions about which tools serve their specific needs. The regulatory frameworks will also help authorities identify genuinely problematic practices without discarding useful innovations or creating unnecessary barriers to entry for new providers with better methodologies.

The Path Forward

ESG ratings are not disappearing from the financial landscape. They have become too embedded in investment processes, regulatory frameworks, and market infrastructure to simply vanish because of criticism. The future lies in evolution rather than abolition - better methodologies, clearer communication, stronger governance structures. The Fraser Institute correctly identifies serious flaws in the current system. Rating quality varies wildly across providers. Disclosure often proves inadequate for sophisticated users. Conflicts of interest abound throughout the industry. However, the lawsuit framing misses the fundamental point about where reform efforts should focus.

The legal foundation for ESG integration remains solid where material risks are properly identified and assessed. The challenge involves improving execution rather than abandoning the enterprise entirely. Both EU and UK regulation recognise this reality. These frameworks are not attempting to suppress ESG ratings or mandate uniform approaches across all providers. Instead, they are creating accountability structures while preserving space for methodological innovation. The goal involves building a more transparent, professional, and ultimately trustworthy ecosystem where different approaches can coexist provided they meet minimum standards for disclosure and governance.

This evolution will not satisfy all critics or advocates. Those who see ESG as inherently political will not be mollified by better disclosure requirements. Advocates who want ratings to drive real-world impact will remain frustrated by their risk-focused design limitations. However, for the vast majority of market participants who simply want useful tools for managing long-term investment risks, professionalisation represents clear progress toward more effective capital allocation.

The conversation should focus on making ESG ratings better rather than eliminating them entirely. This means demanding transparency from providers, rewarding quality over marketing, and maintaining healthy scepticism about any tool that claims to capture complex realities in simple scores. The approach also requires understanding what these tools actually do - and do not do - in today’s financial system. ESG ratings measure financially material risks. They do not measure corporate virtue, and they do not guarantee real-world outcomes. Getting that distinction right proves essential for everyone involved - investors, companies, regulators, and critics alike. The lawsuit frame obscures more than it clarifies. The real work lies in making ESG ratings more transparent, accountable, and fit for purpose.