The Treasury has reaffirmed its commitment to give the Financial Conduct Authority powers to regulate environmental, social and governance (ESG) rating providers, to “improve transparency” in their processes.
The finance ministry said today (6 March) that these providers will be regulated where assessments of ESG factors are used for investment decisions and influence capital allocation.
This, it insisted, will “improve clarity and trust” in these ratings.
The Treasury ran a consultation in the spring of last year to examine what a potential regulatory regime for rating providers might look like.
A full response and legislative steps will follow later this year.
ESG ratings can cover a wide range of things, and they are often used to steer investments.
They can assess an entity’s exposure to and management of ESG risks, such as flooding risk, or ESG opportunities, such as trends like clean technology.
Alternatively, it can assess an entity’s impact on wider ESG matters, such as a company’s impact on air quality due to its carbon emissions.
ESG ratings are sometimes compared with credit ratings.
However, they are inherently multidimensional, unlike credit ratings which focus on only the creditworthiness of an entity or financial instrument.
In Focus: Should advisers use ESG ratings?
CCLA head of sustainability James Corah said the ESG ratings market “leaves much to be desired”.
“It is clear that for many, their purpose is misunderstood,” he said.
“Rather than providing an objective account of the social and/or environmental impact of companies, the majority of ratings products solely provide opinion on the financial risk that sustainability poses to the businesses they analyse.
“If we are to build an investment industry that genuinely focuses on building a better world this needs to change.
“ESG ratings need to focus less on financials and instead rate reality. This is the only way that the ESG ratings industry can introduce commonality, objectivity and – most importantly – provide the tool that investors really need to properly inform investment decisions and be a catalyst for change.”
In a consultation paper on climate-related disclosures and ESG in capital markets (CP21/18), the FCA asked market participants about the case for regulatory oversight of ESG ratings and ESG data providers.
Respondents agreed with the areas identified by the FCA as posing potential harm from the provision of ESG ratings and ratings-like products.
These include a lack of transparency, poor governance and systems and controls, poor management of conflicts of interest, and issues related to engagement with the rated entity.
The FCA has concluded there is a “clear rationale” for regulatory oversight of certain ESG ratings and data providers when their products are used in financial markets.
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