FCA supports regulation of ESG ratings

FCA supports regulation of ESG ratings

The Financial Conduct Authority has expressed its support for the regulation of ESG data and ratings agencies after consulting the industry.

In a feedback statement released this morning (June 29), the FCA said it supported the government’s consideration of bringing the oversight of these products and services under the regulatory umbrella.

The city watchdog said this would contribute to its overarching aims, which are to protect consumers and the integrity of the UK financial system, as well as promoting effecting competition in the interests of consumers.

Director of environment, social and governance at the FCA, Sacha Sadan, said the focus of the regulator's ESG strategy is to build trust and integrity in financial instruments and products that are sold as sustainable.

“As our recent discussion with industry and other stakeholders shows, that requires close international cooperation on standards and actions right across the market.

"We would support a future regulatory regime in line with international recommendations.”

ESG ratings

As industry participants more fully integrate ESG into their activities and expand their ESG-focused product offerings, the regulator said in its statement, they are increasingly reliant on third-party ESG data and ratings services.

These services are becoming increasingly embedded within investment processes, it added, directly influencing capital allocation.

Most respondents to the request for feedback supported an increase in regulatory oversight.

The regulator also acknowledged that that there is a very low correlation between different providers’ ESG ratings on any given entity, but indicated it does not think this is a potential issue for the industry. 

This reflects the “inherent multidimensionality of ESG”, it said, as well as the always-improving methodology. 

Despite this, the FCA said it does not consider these differences a source of harm, as long as the providers are transparent about their methodology and the data they use, have robust governance, manage conflicts of interests and have systematic processes and controls.

The case for ESG ratings

ESG ratings have come under fire recently with experts saying they should be viewed as opinions.

Will Collins-Dean, and Eric Geffroy, a senior portfolio manager and investment strategist respectively at Dimensional Fund Advisers, said given the “subjectivity inherent in ESG ratings”, they should be viewed as opinions, similar to the buy, hold or sell opinions used by sell-side analysts.

However, the regulations could reduce the concern among advisers over the lack of transparency on ESG definitions.

The move could also assuage worries that advisers will be judged on asset allocation decisions made today by criteria developed in the future.

Next steps

The FCA and Treasury will have to undertake a consultation before implementing any regulations, and the regulator said it will seek to align itself with the IOSCO’s recommendations released last year.

“We see value in coordinating as far as possible with other jurisdictions, on the design of any regulatory approach or voluntary code of conduct," the FCA said.