FCA to regulate ESG ratings providers
Environmental, Social and Governance (ESG) ratings providers will be policed by the Financial Conduct Authority (FCA) under plans published by the watchdog citing concerns of conflicts of interest and a lack of transparency in the burgeoning industry.
In what promises to be the most radical overhaul of sustainable finance regulation in UK history, the City’s main watchdog has launched a formal consultation to bring agencies that provide ESG ratings under its remit.
The agencies assess the performance of companies and funds against various environmental and social inclusion criteria. As more major funds have incorporated ESG into their investment strategies, the ratings agency industry, which tends to charge portfolio companies and investors, has grown to an estimated $2.2bn (£1.6bn) globally.
Transparency concerns
But their rapid growth has been accompanied by concerns over a paucity of transparency and consistency across different providers, with many using different, often opaque methodologies to come to their assessments.
The FCA is also concerned about the extent of conflicts of interest in the sector. Some agencies also have ties to ESG consultancy services with a client base that overlaps with the pool of firms they are responsible for rating.
Under the FCA proposals, ratings agencies will be obliged to share information on their methodology and data sources with the regulator, and identify, manage and disclose any conflicts of interest.
“We are encouraged to see the FCA’s proposals to regulate ESG ratings providers,” said James Alexander, chief executive of the UK Sustainable Investment and Finance Association.
“We particularly welcome the emphasis on transparency and consistency with international standards in the consultation paper – in line with previous International Organisation of Securities Commissions (IOSCO) recommendations.
City still aiming to cut red tape
The decision to bring ESG ratings under the watchdog’s purview comes despite a wider attempt from central government to clamp down on excessive and overly burdensome regulation. Both the Chancellor and Prime Minister have thrust deregulation at the heart of the “number one mission” to kickstart elusive economic growth.
At the end of last year, they wrote to the bosses of the UK’s largest watchdogs demanding to be sent dozens of ideas for ways to pare back excessive red tape on the private sector and how to “regulate for growth”.
The FCA estimated the ESG proposals, which will now be open to a consultation process culminating in March next year, would bring £500m in net benefits over the next decade, thanks to reduced due diligence and compliance costs.
In a consultation paper published on Monday, the watchdog also said the move had the support of 95 per cent of investors who responded to a government survey to assess industry demand.
Andy Ford, head of responsible investment at St. James’s Place, said: “This is a positive step. A lot has been made of how ESG ratings can differ between providers, but that’s often due to different methodologies being used.”
“However, we shouldn’t overstate the impact of bringing ratings agencies into the regulatory perimeter. In our view, investment managers shouldn’t be overly reliant on third-party ratings,” he added. “We prefer our managers to use them as one input among many, comparing external assessments with their own in-house analysis rather than outsourcing judgement.”