Passive ESG and the Governance Question: Why Third-Party Data Deserves More Scrutiny

Passive investing has become a central allocation tool for many European institutions. In conversations with market participants, this shift is closely linked to sustained cost sensitivity and the difficulty many active strategies have faced in consistently delivering outcomes that justify their fees over longer horizons.

Recent European fund flow data reinforces this trend. European open-end funds and ETFs, excluding money market funds, gathered €184.2bn in the first quarter of 2026, with passive strategies accounting for €120.0bn, or 65% of net inflows. Separately, the European ETF industry recorded €107.5bn of net inflows during the same period, with total ETF assets reaching €2.66tn by the end of March 2026.¹ ³

Over the same period, evidence on active performance has remained mixed, but the overall pattern is clear. The latest SPIVA Europe scorecard shows that in 2025, a majority of European-domiciled active equity funds underperformed in 18 of 21 reported equity categories, including 71% of euro-denominated global equity funds and 82% of euro-denominated pan-European equity funds. ² While outcomes vary across segments, the broader direction is well understood across the industry.

Cost dynamics continue to play an important role. ESMA’s latest costs and performance report show that, between 2020 and 2024, ongoing costs fell by 8% for retail equity UCITS excluding ETFs and by almost 15% for retail bond UCITS excluding ETFs. Over the same period, ongoing ETF costs fell by 13% for equity ETFs and 17% for bond ETFs. ⁴ Large European asset managers continue to position passive products as efficient building blocks within portfolios, reinforcing the structural nature of this trend rather than presenting it as cyclical.

A similar dynamic is evident within ESG products. Available regulatory analysis does not indicate a systematic ESG cost premium in Europe. ESMA reports that retail ESG UCITS and non-ESG UCITS both had aggregate ongoing costs of 1.0% in 2024, while its regression analysis indicates that ESG funds exhibit a marginally lower total expense ratio after controlling for other factors. ⁴ At the same time, the picture is not entirely uniform. European sustainable funds returned to positive net inflows in the first quarter of 2026, but the recovery was concentrated in passive sustainable funds, which attracted $24.0bn, while active sustainable funds experienced $14.8bn of redemptions.⁵ This suggests that ESG integration within passive structures continues to evolve, both in terms of pricing and investor demand.

In discussions with passive managers, the appeal of passive ESG remains clear. It offers scalability, rule-based implementation and a degree of transparency that aligns with institutional expectations. At the same time, this structure raises a question that warrants closer attention:

Passive ESG strategies typically rely on indices that incorporate sustainability criteria. These may include exclusions, controversy filters, business involvement thresholds or alignment with frameworks such as the UN Global Compact. By design, the asset manager replicates the index rather than reassessing each underlying decision. This approach is both efficient and consistent with the broader philosophy of passive investing.

However, it also means that a significant portion of ESG judgement sits upstream, within ESG data providers and index construction methodologies. This creates a clear governance blind spot. While the end product remains the responsibility of the asset manager, the underlying ESG determinations are not always subject to independent validation.

This is not to suggest that ESG data providers or index methodologies are inherently problematic. They play a critical role in enabling scalable ESG implementation. At the same time, ESG data involves interpretation. Decisions around controversy severity, revenue classification, screening thresholds or data estimation are not purely mechanical and vary across providers.

Regulatory and supervisory bodies have increasingly highlighted these challenges. IOSCO has pointed to differences in methodologies, limited transparency in some cases and uneven issuer coverage across ESG ratings and data markets. ⁶ Similarly, the EU ESG Ratings Regulation places a strong emphasis on transparency, governance, conflicts of interest and the disclosure of methodologies and data sources. ⁷ These developments reflect a broader recognition that ESG data forms part of the market infrastructure rather than a purely technical input.

In this context, the risk is not limited to isolated data inaccuracies but extends to the potential for a reinforcing feedback loop. The same ESG dataset may influence index construction, portfolio replication and, in some cases, product-level reporting. Where a classification is contested, or where methodologies evolve, the impact can propagate through the investment chain without being independently reassessed.

This dynamic is particularly relevant in the context of rules-based screening frameworks, such as UN Global Compact or OECD-aligned approaches. These frameworks are widely used and serve an important purpose. However, their application depends on underlying data inputs and interpretation. Where asset managers rely exclusively on index-level implementation, there is limited scope to cross-check or challenge outcomes in borderline cases.

From a governance perspective, this raises a broader consideration. Passive ESG strategies are often described as transparent due to the disclosure of index rules. However, transparency of rules does not equate to transparency of underlying data or judgement. A methodology may be clearly articulated while still relying on inputs that are estimated, subject to revision or interpreted differently across providers.

Regulatory perspectives are increasingly aligned on this point. IOSCO recommends that users of ESG data conduct due diligence on what is being assessed, how it is assessed and what limitations may exist. ⁶ The FCA has also highlighted the growing reliance on third-party ESG data and emphasised the importance of governance, controls and transparency in its use. ⁸ While these observations apply across the industry, they are particularly relevant for passive ESG strategies given their structural reliance on external inputs.

In practical terms, this does not imply that passive managers should replicate the work of ESG data providers. Rather, it suggests that ESG data should be treated as part of the governance framework rather than purely as an operational input. This includes understanding which datasets underpin index construction, how key screens are implemented, how methodology changes are communicated and how exceptions are handled.

Independent validation also has a role to play. This does not require a parallel research process, but selective cross-verification—particularly for high-impact classifications—can help identify inconsistencies and provide additional confidence in outcomes. Even limited triangulation strengthens the overall governance framework.

Passive ESG strategies are not inherently less effective than active approaches. They offer a disciplined and scalable means of integrating sustainability considerations. However, as reliance on third-party data increases, governance considerations become more important.

The next phase of passive ESG will therefore be shaped not only by cost and growth, but by the extent to which asset managers can demonstrate oversight of the ESG judgements embedded within their products. Dependency on external inputs has increased. Governance now needs to keep pace.

1. Morningstar – Europe Fund Flows: ETF Inflows Keep Increasing in 2026

2. S&P Dow Jones Indices – SPIVA Europe Year-End 2025

3. LSEG Lipper – European ETF Industry Review Q1 2026

4. ESMA – Costs and Performance of EU Retail Investment Products 2025

5. Morningstar – Global Sustainable Fund Flows: Q1 2026 in Review

6. IOSCO – ESG Ratings and Data Products Providers Final Report

7. European Commission – ESG Ratings Regulation

8. FCA – Code of Conduct for ESG Data and Ratings Providers