The government has announced plans to regulate firms providing ESG ratings of company environmental, social and governance (ESG) performance, according to news reports.

The announcement by Rachel Reeves, Chancellor of the Exchequer, picks up on plans by the previous administration, which had intended to mandate a code of conduct for ratings agencies assessing environmental, social and governance (ESG) data by the end of 2024. It had already opened an initial public consultation on the matter.(1)

The proposed legislation would aim to stop greenwashing by firms that rate the quality of  sustainable investments, requiring  ESG ratings agencies to show in detail which  metrics, data and assumptions they used to reach their calculations.(2)

A Treasury statement explained: "Rachel Reeves has asked the Treasury to respond quickly to an industry consultation on a new regulatory regime for ESG rating providers and bring forward legislation next year. 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.” (3)

In SaveMoneyCutCarbon’s view, this schedule would mean that implementation is likely to take effect towards the end of 2025, and would help to clarify the benchmarking processes that help to guide billions of pounds into sustainability-focused investment funds.

James Alexander, chief executive of the UK Sustainable Investment and Finance Association (UKSIF), said that years of work to convene the industry should propel decisive government action. (4)

 “A lack of clarity and transparency around some ESG ratings, where providers can sometimes come out with vastly different ratings of the same business, have caused confusion by not clearly outlining the methodologies used.

“This regulation should help open the black box on these sorts of judgments, not by forcing agreement or consensus, but by shining a light on how the underlying data is gathered and how ratings are calculated.”(5)

According to reports, the Financial Conduct Authority (FCA) would be responsible for supervising ESG ratings. The FCA launched a voluntary code of conduct earlier this year for ESG ratings and data products providers while it has also welcomed the voluntary code of conduct for ESG ratings and data products providers launched at the end of last year by the International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG). (6)

In February, the EU agreed on a mandatory code of conduct for ESG ratings agencies, aligned with the International Organisation of Securities Commissions (IOSCO) recommendations made in November 2021, which included requiring providers to identify and disclose potential conflicts of interest, and to consider the data and methodologies used. (7)

The Treasury confirmed that the proposed law announced by Chancellor Reeves would be aligned with recommendations on ESG ratings IOSCO. (8)

In August, the  FCA introduced a labelling scheme for ESG funds, to encourage transparency and accuracy when describing strategic approaches. The labels, in development since 2023, aim to curtail vague and potentially misleading references to ESG impacts of funds. Asset managers using the labels will need to provide “clear, complete” information and select one of four specific fund labels:

• Sustainability Focus

• Sustainability Improvers

• Sustainability Impact

• Sustainability Mixed Goals

The FCA does not grant approvals but needs to be made aware of label adoption, revision or removal and asset managers will need to demonstrate that at least 70% of the fund’s assets support the chosen label. (9)

The EU has published a green finance taxonomy, a classification system that defines criteria for economic activities aligned with net zero 2050 goals and broader environmental goals beyond climate. It classifies which investments can be described as “green” and which cannot. The EU says that the taxonomy is the “cornerstone of the EU’s sustainable finance framework and an important market transparency tool. It helps direct investments to the economic activities most needed for the transition, in line with the European Green Deal objectives.” (10)

The UK is in the process of developing its own taxonomy with a further announcement in April 2023 by the previous government of intention to move forward11 but there have been significant delays, with as yet no finalisation date. (12)

In SaveMoneyCutCarbon’s view, the various initiatives around ESG ratings regulations and the planned legislation should help to strengthen the Chancellor’s vision to make the UK a world leader in sustainable finance, giving investors confidence and companies the funds they need to develop sustainable and profitable green business strategies, boosting their ESG performance.

Sources:

1 edie (accessed August 2024) ESG ratings agencies to be regulated in UK, new Government confirms https://www.edie.net/esg-ratings-agencies-to-be-regulated-in-uk-new-government-confirms/

2 edie (accessed August 2024) ESG ratings agencies to be regulated in UK, new Government confirms https://www.edie.net/esg-ratings-agencies-to-be-regulated-in-uk-new-government-confirms/

3 Reuters (accessed August 2024) Britain to propose law next year to regulate ESG raters https://www.reuters.com/world/uk/britain-propose-law-next-year-regulate-esg-raters-2024-08-08/

4 edie (accessed August 2024) ESG ratings agencies to be regulated in UK, new Government confirms https://www.edie.net/esg-ratings-agencies-to-be-regulated-in-uk-new-government-confirms/

5 edie (accessed August 2024) ESG ratings agencies to be regulated in UK, new Government confirms https://www.edie.net/esg-ratings-agencies-to-be-regulated-in-uk-new-government-confirms/

6 ESG Today (accessed August 2024) UK to Introduce Law to Regulate ESG Ratings Providers https://www.esgtoday.com/uk-to-introduce-law-to-regulate-esg-ratings-providers/

7 ESG Today (accessed August 2024) UK to Introduce Law to Regulate ESG Ratings Providers https://www.esgtoday.com/uk-to-introduce-law-to-regulate-esg-ratings-providers/

8 edie (accessed August 2024) Asset managers to start using new anti-greenwashing fund labels this week https://www.edie.net/asset-managers-to-start-using-new-anti-greenwashing-fund-labels-this-week/

9 ESG Today (accessed August 2024) UK to Introduce Law to Regulate ESG Ratings Providers https://www.esgtoday.com/uk-to-introduce-law-to-regulate-esg-ratings-providers/

10 European Commission (accessed August 2024) EU taxonomy for sustainable activities https://finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en

11 GOV.UK (accessed August 2024) Mobilising green investment: 2023 green finance strategy – annexes https://www.gov.uk/government/publications/green-finance-strategy/mobilising-green-investment-2023-green-finance-strategy-annexes

12 edie (accessed August 2024) UK Government receives final advice on forming a green taxonomy https://www.edie.net/uk-government-receives-final-advice-on-forming-a-green-taxonomy/