Will ESG rating agencies be included in the scope?

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With the current focus on ESG investing, over the past year the role and ratings produced by ESG rating agencies have been increasingly highlighted. A key question that arises is whether ESG rating agencies should be brought into the regulatory scope.

It has been suggested that ESG rating agencies may struggle to keep up with the speed at which the ESG market is developing. More recently, a report published by the International Regulatory Strategy Group (IRSG) ignited this conversation.1

The IRSG believes that regulation of ESG ratings is desirable to provide “more transparency around the basis of ESG ratings and mitigation of potential conduct risks“. 2

What is the regulator’s opinion?

Last summer, the FCA published its consultation document CP21/18 “Improve climate disclosures by standard listed companies and solicit views on ESG topics in capital marketsyou”3 He looked at the methodological issues and risk models of ESG rating agencies. In this consultation paper, the FCA has sought views on whether the FCA should engage with the Treasury to consider bringing the activities of ESG data and rating providers into the FCA’s regulatory scope, or whether to simply encourage ESG data and rating providers to adopt a voluntary Code best practice. Some of the areas of concern regarding ESG data and rating agencies include:

  • there “wiring” ESG ratings in the investment process;
  • a lack of transparency in methodologies and interpretability of ESG ratings;
  • the need to ensure good governance and the management of conflicts of interest; and
  • the costs to issuers of responding to data requests from providers.

Following this, the FCA scope report 2020/214 made similar ideas and noted that the FCA will issue a commentary statement on the subject in the first half of 2022.

In the same month, the British government also demonstrated its commitment by publishing its “Greening Finance: A Roadmap for Sustainable Investing“.5 In the publication, he acknowledged that”different ESG rating agencies issue opinions on different aspects of sustainability performance and their ratings are not always comparable“and noted that as a result the government is”therefore considering bringing these companies within the scope of FCA authorization and regulation“.6 The government is expected to release more details on this later this year.

Since then, the CEO of FCA (Nikhil Rathi) has met with the Economic Secretary to the Treasury (EST) to discuss matters set out in the FCA scope report, including ESG data and ratings. It was recorded that “EST noted that there had been discussions about ESG ratings and the possibility of bringing suppliers into the scope. The CEO noted that there was support for the government’s work to consider bringing ESG ratings providers into the scope.7

Is regulation likely?

It looks like we’re headed in that direction. It is hoped that this will improve the consistency and accuracy of ESG ratings and ultimately lead to less risk for companies when deciding which ESG investments to make.

There also appears to be a similar direction in the European Union, with the European Commission updating its sustainable finance strategy and ESMA launching a call for evidence in February. We will monitor this space.

  1. IRSG, ‘ESG Ratings and ESG Data in Financial Services – The Practitioner Perspective‘ February 2022. Available here: https://www.irsg.co.uk/assets/Reports/IRSG-Accenture-report-on-ESG-Ratings-and-ESG-Data-in-Financial-Services-FINAL-2 .pdf.
  2. Available here: https://www.fca.org.uk/publication/annual-reports/perimeter-report-2020-21.pdf.
  3. Available here: https://www.gov.uk/government/publications/greening-finance-a-roadmap-to-sustainable-investing.
  4. https://www.gov.uk/government/publications/hm-treasury-and-financial-conduct-authority-regulatory-perimeter-meeting-december-2021/hm-treasury-and-financial-conduct-authority-regulatory- meeting-scope-december-2021.
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