The UK government’s plans to regulate ESG rating agencies will help to provide ‘better transparency between the different players in the market’, according to a leading IRO.
The new Labour chancellor Rachel Reeves announced on August 8 that a new piece of legislation to regulate ESG rating providers in the country could come into force next year.
Announcing her plans during her business trip to Toronto last week, Reeves said it’s time for the UK Treasury to gather responses to the consultation on this matter which opened in March last year. Following that, and before the chancellor’s statement last week, plans to regulate the sector were also announced by the former chancellor Jeremy Hunt in the Spring Budget 2024 published in March this year.
‘Growth is top of my agenda. We are forging a new partnership with industry to get finance to the best, most innovative and most sustainable companies so that we can unleash Britain’s potential,’ said Reeves last week.
The plans will help issuers understand exactly what ESG rating agencies consider when producing their final scores for companies, says Angela Catlin, head of IR, corporate affairs and brand at The Co-operative Bank.
Welcoming the chancellors’ plan, Catlin says she hopes the new bill would help investors make more informed decisions by establishing a set of methodologies ESG rating agencies would have to adhere to.
‘While The Co-operative Bank consistently scores highly across the piece given our commitment to values and ethics, including being the UK’s best ESG rated high street bank by Morningstar Sustainalytics, some of our peers see much more varied scores depending on the methodologies provided,’ she tells IR Magazine.
‘While having varied methodologies is not a bad thing, moving to a more consistent approach will help investors to better identify the companies that are truly demonstrating a strong ESG approach and ESG capabilities. In addition, alignment across the EU will help ensure investors can make wider comparisons across different industries, supporting the global requirement for more efficient ESG capital allocation.’
In April 2024, the EU Parliament adopted a new piece of regulation to foster transparency and integrity of ESG ratings providers’ activities in the EU. Experts say the UK’s upcoming bill would mostly mirror the European one.
Caitlin says the new legislation should focus on better disclosure on behalf of ESG rating agencies on methodologies used to score companies and all factors considered to inform ratings.
‘We are already seeing ESG rating agencies move to unsolicited models in light of the impending legislation,’ she adds. ‘As ESG rating agencies move to look only at public disclosures, we would expect the role of ESG rating agencies change or evolve to avoid being seen as data collection and comparison tools. The UK government will need to strike the right balance between driving transparency, whilst ensuring agencies can still provide value to ESG investors.’
The move to regulate ESG ratings providers forms part of Reeves’ wider plans to boost investor confidence and grow the economy by unlocking more finance-innovative, well-governed and sustainable companies.
‘The chancellor sees an opportunity to work with industry to drive more investment and cement the UK as a world-leader in sustainable finance, starting by addressing the lack of transparency behind ESG ratings,’ the Treasury says in a statement.
‘The new approach will boost growth, help deliver a cleaner economy and ensure that companies in critical sectors like defence are not penalised by opaque ratings. They will also align with recommendations set by the International Organisation for Securities Commission (IOSCO), helping break down barriers to financial services companies operating across borders, enhancing the UK’s international competitiveness and delivering economic growth.’
Reeve’s announcement was broadly welcomed by investors and other industry players. ‘This is the product of work we have been pleased to undertake over the last year with our membership, government and FCA, which we hope will ultimately deliver greater transparency and trust among investors in the ESG ratings market in the UK,’ says Oscar Warwick Thompson, Head of Policy at sustainable finance group UKSIF.
‘We have seen a lack of clarity around the methodologies that are used by some providers to calculate their metrics, in particular for rating products, and the process by which some ESG ratings are determined.
‘We want to see a new regulatory framework in the UK reduce ‘black box’ methodologies, take account of the definitional challenges and carefully consider international consistency, including with the EU’s recently finalized approach and the IOSCO’s recommendations.’
Thomson argues, the lack of a clear and consistent framework has set the UK back compared to other jurisdictions, where more progress has been made.
‘International alignment would be welcome, helping to reduce barriers for UK investors in accessing ESG ratings and products and hopefully help keep costs for end-users reasonable.’
At a glance
Timeline of ESG ratings-related regulatory moves and proposals in the UK and the EU so far:
- In November 2021, the IOSCO calls for increased transparency and publishes a series of recommendations for regulators and market participants to consider. Recommendations focus on increased transparency, good governance, management of conflict of interests and the establishment of a set of robust systems and controls in the form of written policies, processes and methodologies.
- In November 2022, the UK FCA announces it has appointed the International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG) to develop a code of conduct for ESG fata and ratings providers. The FCA asks that the code takes into account IOSCO recommendations and other related developments on the matter in other jurisdictions, such as the EU. From this point, the authority and the UK HM Treasury alongside other national and international financial regulators would act as observers as the code shaped up.
- In March 2023, the UK HM Treasury opens a consultation on the back of the UK’s update Green Finance Strategy that had been published on the same day. The consultation asks whether and how the FCA’s ‘regulatory perimeter’ should be extended to include ESG ratings providers.
- In June 2023, the European Commission presents a proposal to regulate ESG rating activities in the EU. Among other things, it asks industry players whether providers of ESG ratings and scores should be authorized and supervised by the European Securities and Markets Authority; for transparency and fairness of fees; whether third-country providers can operate in the EU market if equivalent, endorsed or recognized and to establish a set proportionate and principle-based organizational requirements.
- In December 2023, ICMA publishes a voluntary code of conduct for ESG rating and data providers.
- In February 2024, the Council of the EU and the European Parliament reach a provisional agreement on the June 2023 proposal.
- In March 2024, the former UK chancellor Jermy Hunt publishes the Spring Budget. Page 81 includes a mention of intent of regulating ESG ratings providers in the UK. ‘ESG ratings providers will be brought into the regulatory perimeter of the FCA,’ reads the whitepaper.
- In April 2024, the EU Parliament adopts the regulation to foster transparency and integrity of ESG ratings providers’ activities in the EU.
- In August 2024, just over a month since being appointed UK chancellor, Rachel Reeves, calls for HM Treasury to the consultation opened in March 2023 and establish a regulatory regime for ESG rating providers by 2025.
