The financial services industry has been reacting to the news that ESG ratings providers will be brought into the regulatory perimeter of the Financial Conduct Authority (FCA), announced as part of the UK government’s Spring Budget, with many welcoming it as “a step towards greater clarity and trust in this evolving market”.
Last year, the government published a consultation on the proposal, in which the growing importance of ESG ratings was highlighted by treasury lords minister, baroness Joanna Penn: “With projections that $33.9trn of global assets under management (AUM) will consider ESG factors within three years, the importance of reliable ESG information is critical and growing. ESG ratings – which assess firms’ management of ESG risks, opportunities and impacts – are a key element of this. “
The consultation document went on to say that, considering industry concerns, international initiatives and the FCA’s view, the Treasury “recognises that growing reliance on unregulated ESG ratings, particularly in investment decisions, can raise risks”, which could impact both the performance of investments and the credibility of the sustainable investment market. Therefore, the Treasury considered that “there is clear benefit to be gained from improving the transparency of methodologies, governance and processes of ESG ratings providers”, and that these outcomes could be brought about through regulation.
After the announcement at Spring Budget 2024, an FCA spokesperson said: “We welcome the government’s decision. We will work to develop a proportionate and effective regulatory regime with a focus on transparency, good governance, managing conflicts of interest and proper systems and controls.
“Having an effective, transparent market for ESG ratings will improve credibility and trust, support the green finance market and competitiveness of the UK economy.
“The FCA supported the development of an international Code of Conduct, grounded in International Organisation of Securities Commissions (IOSCO) recommendations. We encourage all ESG data and ratings providers to sign up to the Code.”
Reaction
Oscar Warwick-Thompson, head of policy at the UK Sustainable Investment and Finance Association (UKSIF), said the regulation of ESG ratings announced in the Budget paves the way for a more transparent and reliable ESG ratings market in the UK.
“UKSIF contributed to this consultation, working closely with our members who, with £19trn in AUM, constitute a huge portion of the global economy, and who have a clear interest in making ESG a robust and effective framework to holistically measure risk,” Warwick-Thompson continued.
“While details surrounding the consultation response and legislative timeline are yet to come, this initial announcement demonstrates the government’s commitment to addressing potential concerns surrounding ESG ratings. It should allow industry time to prepare for further discussions and potential changes, paving the way for a more transparent and reliable ESG ratings market in the UK.
“UKSIF submitted its response to the government’s consultation on ESG ratings regulation, reiterating our support for both the FCA’s and Treasury’s initiatives in this domain. UKSIF has emphasised the need for transparency throughout the process of constructing ratings, including clear methodologies and regular reviews of how ratings are calculated to eliminate ‘black box’ practices and ensure greater rigor in the market.
“Crucially, our response also emphasised the need for international alignment with the EU’s developing regulations to promote innovation, reduce barriers for UK investors and support smaller players in the market. We also called for improved dialogue between ratings providers and investors to address material data gaps and ensure providers can better understand user needs.”
See also: – ESG ratings providers must prepare to jump through regulatory hoops after latest EU proposals
Meanwhile, Arthur Carabia, director of ESG policy research at ratings provider Morningstar Sustainalytics, said that UK ESG ratings regulation “is very important to us”.
“We will continue to be closely engaged in this process. Given the global nature of ESG ratings and shared policy objectives, we hope that the UK regulation will converge with the EU regulation allowing a form of equivalence.”
Equally, Dr Matthias Breier, head of ESG product at FE FundInfo said they too support transparency to enhance trust in the ESG industry.
“Although we know no further details yet – the Treasury announcing only that ‘a full consultation response and legislative steps will follow later this year’ – there is an interim voluntary code of practice in place in the meantime.
“We are urging for more transparency on data to provide full disclosure on origin and manipulation, a clear overview of underlying models, a reduction and disclosure of potential conflicts of interest, and the addition of a change log for methodology modifications.”
European rules
The news comes after the European Securities and Markets Authority (ESMA) was given regulatory powers over ESG ratings in Europe. ESG ratings providers will need to seek approval to ensure they comply with transparency requirements under rules that were provisionally agreed by the European Council and European Parliament in February.
There have been previous concerns investors are overly reliant on ESG ratings in their research, while not fully understanding the variability of different ratings providers’ methodologies.
