The UK is expected to announce a new regime for overseeing ESG rating providers, a move that comes hard on the heels of a report indicating continued frustration with the metrics among investors.
Ministers are expected to unveil their proposals early in 2024, following industry consultations earlier this year and months after the nation’s regulator said it would implement a voluntary code of conduct. The government launched discussions after British institutions added their voices to international concern that ESG ratings were not serving investor needs and are enabling greenwashing.
The news of an announcement – reported by the Financial Times and supported by other media – suggests that the government of Prime Minister Rishi Sunak is working to ensure the regulation dovetails with one being drawn up the EU, observers have said.
European Commissioners have begun a second round of consultations on the bloc’s ESG Rating Regulation. They have taken pains to ensure new guidelines aren’t hastily thrown together in a way that could stymie still-evolving sustainability markets. Ratings expert Daniel Cash said such a strategy is a sound one.
“If the UK government has any sense at all, which they do have given the sensitivities that come with housing one of the world’s leading financial centres, they will not go ‘gung-ho’ at this early stage of the ESG rating market, and the sustainable/ESG-linked investment marketplace moreover,” Cash, the ESG ratings and regulations lead at international law firm Ben McQuhae and Co, told ESG Insight. “Getting it wrong could be catastrophic, and the regulators and legislators are well aware of this.”
Code of Conduct
The UK government closed its consultation on regulating the raters in June and the last formal announcement on the matter from the Treasury came soon after, to say it was examining the responses. In July, the regulator, the Financial Conduct Authority (FCA), said it would create a voluntary code of conduct that providers would be expected to follow.
Authorities have been mulling how to address criticism of the rating firms, who are influential in guiding the allocation of almost £5 trillion of capital towards companies and projects that can further the goals of the Paris climate agreement.
Companies such as MSCI, ISS ESG and Moody’s offer a range of ESG ratings and indexes but have come under scrutiny as the importance of the metrics has grown. They face complaints that they often give widely differing scores for the same companies and assets. Critics say the companies are too secret about the methodologies they use to arrive at their ratings, with some describing them as “black boxes”.
Without comparable metrics investors say they are hamstrung in their decision-making processes. The absence of transparency in the ratings’ methodologies also prevents them from interrogating data to safeguard against greenwashing.
Continued Frustration
The investment industry continues to air its frustrations, most recently in a survey published last week by the Association of Investment Companies (AIC). In its latest ESG Attitudes Tracker, the AIC found that just a fifth of advisers and wealth managers interviewed said they trusted ESG ratings. And just one quarter of respondents said ratings eased their concern over greenwashing.
The report cited one adviser as saying: “There needs to be more industry standard regulations on ESG ratings. It’s a minefield.”
Reports said that the UK government is weighing whether to create a new regulator to oversee the rating providers or to bring them under the purview of the existing overseer. In the EU, commissioners are thought to prefer the latter approach for their regulation. Progress of the proposal has been dogged with controversy, including accusations that it doesn’t chime with the bloc’s broader green agenda.
Cash thinks the UK is most likely to follow the EU’s lead.
“If they formally regulate via a new piece of legislation, they will give the FCA the power rather than create a new regulator – the market is not big enough to warrant a new regulator in the UK,” said Cash, who is also a senior law lecturer at Aston University in the UK. “The FCA will likely be given the powers and the Government will likely align to the EU approach, give-or-take some controversial elements – the UK is essentially waiting until the EU sorts out its controversies before following suit.”
Sunak is under pressure from parts of his ruling Conservative Party to get tough on green laws. But observers think this is unlikely to extend to putting undue pressure on ESG service providers.
“The post-Brexit UK must appear to be business-friendly, and being too harsh or brash with ESG rating agencies now would be the opposite,” Cash said. “What is more likely to happen is a very facilitative framework enacted to allow ESG rating agencies to formalise themselves on British shores, but also allow for as much ESG/Sustainability-focused investment as possible.”
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