UK set to unveil regulatory regime for ESG ratings industry

The UK government is set to press ahead with plans to regulate agencies that evaluate the environmental, social and governance performance of companies, the latest in a global crackdown on the sustainable ratings industry.

Ministers intend to unveil formal proposals as early as January next year following a three-month consultation that closed in June, Whitehall insiders told the Financial Times.

The push follows concerns in the UK and elsewhere about a largely unregulated sector that wields broad influence over trillions of pounds worth of sustainable investments.

At present there is little oversight on how organisations create ESG criteria and rate other companies against them. The ratings influence which stocks and bonds make it into investment funds that are marketed as sustainable.

The Treasury is examining whether regulating ESG agencies will require fresh legislation or could be achieved through measures implemented under existing laws, people familiar with the matter said.

The people cautioned that ministers were still formally analysing the consultation responses.

Although a proposal to create a new watchdog has not been ruled out, they added, expanding the remit of the Financial Conduct Authority is considered the likelier option.

The Treasury said it would publish a government response to its consultation on a potential regulatory regime for ESG ratings providers “in due course”. The FCA said: “We continue to work with government on their consultation for a regulatory regime for ESG ratings providers.”

Britain’s move to regulate the sector comes after the European Commission also proposed new rules for ESG rating providers in June.

The Commission proposed measures to separate ratings groups’ provision of data services from their consultancy arms, to ask them to disclose more methodological details and to formally register with authorities.

The FCA, the UK’s markets regulator, has been encouraging the industry to adopt a voluntary code of conduct currently under development, in part because of its uncertainty about its formal powers to oversee the sector.

A working group created at the instigation of the FCA is due to publish the voluntary code for ESG data and rating providers next month.

A draft version of the code published in July said providers should disclose measures they take to avoid conflicts of interest and publish more information about their methodologies, among other reforms.

Sacha Sadan, head of environmental, social and governance issues at the UK’s Financial Conduct Authority, said in July that the code “has been developed with international consistency in mind”. Observers from Japan’s and Singapore’s financial regulators have attended meetings about it.

“We’re not waiting for a crisis [to act],” Sadan previously told the FT about the question of curbing the ESG data providers. The industry has “grown up very fast”, he added.

Pressure has been building on the lucrative market for sustainability data since 2021 when the International Organization of Securities Commissions told financial regulators around the world that they should consider “focusing more attention” on providers of ESG ratings and data.

In the UK Grant Shapps, the defence secretary, warned in September that ESG standards risked undermining Britain’s defence industry by limiting its access to finance.

Jeremy Hunt, the UK chancellor, signalled that the government wanted to improve the transparency and ensure the good conduct of the ESG ratings market as part of his Edinburgh reforms in December last year.

“It’s pure subjectivity hiding under the veneer of objectivity,” said one UK government official, while another complained that a “whole cottage industry of nonsense firms” had sprung up.

Lindsey Stewart, director of investment stewardship research at data and index provider Morningstar, said regulations would be “largely welcome” if they were aimed at “maintaining consistent, transparent methods” and ensuring “an appropriate level of independence” among providers.

But he added that any regulation should also be “flexible enough to allow for innovation so that emerging market needs can be met”.