ESG Investing  

Industry welcomes potential regulation of ESG ratings providers

Industry welcomes potential regulation of ESG ratings providers

The industry has welcomed the government’s plans to bring ESG ratings providers under the UK’s regulatory perimeter.

Last week Jeremy Hunt announced 30 reforms to financial services regulation, rolling part of the regime created after the financial crash in 2008.

As part of these reforms, the government will consult on bringing ESG ratings providers under the Financial Conduct Authority's reach.

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In a statement, the government said HM Treasury will also join the ESG data and ratings code of conduct working group.

“These services are increasingly a component of investment decisions, and the government wants to ensure improved transparency and good market conduct,” it said.

The FCA, which has previously expressed its support for the change, said there was a “strong rationale” for regulatory oversight of these firms.

“We look forward to working closely with the government on the next steps, encouraging regulation that focuses on transparency, good governance, management of conflicts of interest, and robust systems and controls.”

The FCA added it favours a “globally coherent” approach in line with recommendations from the International Organisation of Securities Commission.

IOSCO has previously published recommendations on how to regulate ESG ratings agencies.

ESG ratings, and those who provide them, are becoming increasingly embedded within investment processes, however the FCA recently said there is a very low correlation between different providers’ ESG ratings on any given entity.

Richard Stone, chief executive of the Association of Investment Companies, said there were very high levels of scepticism over ESG claims.

“Regulating to increase market confidence is essential to protect investors and to develop the ESG investment market for the long term…We believe the hurdles to obtain such a label should be meaningful and high.”

“Trust in those ratings is critical.”

Gemma Woodward, head of responsible investment at Quilter Cheviot, said given the proliferation of firms offering ratings on ESG factors, and the different methodologies behind these ratings, it is welcoming to see the government look at benefits of bringing them into the regulatory regime. 

“There is an increasing dependency on data and metrics produced by these firms from asset managers and owners in order to meet regulatory reporting requirements such as TCFD, as well as using these within their responsible investment approaches, such as integrating ESG factors within the investment process.”

The case for ESG ratings

Experts have previously said ESG ratings 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.