The Financial Conduct Authority (FCA) has published its final rules for environmental, social and governance (ESG) ratings providers, introducing new requirement around transparency, and governance.
These new rules are aimed at improving confidence in these ratings , which are widely used by institutional investors including pension schemes.
The FCA said this new framework is designed to address the difficulties investors face in understanding how ESG ratings are produced, comparing different products and identifying potential conflicts of interest.
It is also intended to ensure the UK remains competitive within this market, and supports it position as a centre for sustainable finance.
Under the new rules, providers will be required to publish information about their methodologies, data sources, rating coverage and limitations, alongside additional disclosures for users and rated organisations.
They will also face requirements covering governance, systems and controls, data accuracy and conflicts of interest, while being brought within the senior managers and certification regime (SM&CR) as ‘core’ firms.
The FCA said it had received 90 responses to its consultation, with broad support for the principles-based approach, although respondents raised concerns about proportionality, implementation costs and alignment with European regulation.
Following the feedback, the regulator has made several changes to its original proposals, particularly around transparency and stakeholder engagement.
These include allowing certain disclosures to be provided at product level rather than for individual ratings, and requiring detailed information to be made available to rated organisations on request rather than automatically.
Providers will also be required to notify rated organisations at least two business days before making a new rating available for the first time, although they will no longer need to wait for feedback before publication.
The new regime will come into force on 29 June 2028, with ESG ratings firms required to obtain FCA authorisation prior to that. This authorisation process will start from June 2027.
The FCA has retained requirements for rated organisations to request underlying data, propose factual corrections and access formal complaints procedures.
However, it confirmed that the Consumer Duty would not apply to ESG ratings providers, reflecting the predominantly wholesale nature of the market.
The regulator also confirmed that it would not prescribe a single methodology for ESG ratings, instead seeking to improve transparency while allowing different approaches to assessing sustainability factors.
The FCA estimated that the final regime would generate a net economic benefit of £569.82m over 10 years, against estimated compliance costs of £99.8m.
The estimated costs have increased by £7.95m compared with the original consultation, largely reflecting additional costs for overseas providers establishing an appropriate UK presence.
As part of its wider work, the FCA also announced plans to undertake a targeted desk-based review of asset managers’ use of proprietary ESG ratings in fund marketing materials. It will continue to assess whether further regulatory action is needed for benchmark administrators, investment research providers and investment consultants.
Quilter Cheviot head of responsible investment Gemma Woodward says this is a welcome step to make a “burgeoning industry a more transparent, and ultimately useful one”.
She adds: “ESG ratings have grown in popularity over recent years as demand for responsible and sustainable investments proliferated quickly at the turn of the decade, yet so much of what went into them was subjective and interpreted in differing ways. As such, moving to a regime where disclosures are clearly made around methodologies, data samples, AI and limitations, amongst other things, should result in better decision making for investment professionals.”
“ESG ratings have been shown to have real influence over investment decisions, with asset managers often over-relying on what they provide to comply with their own reporting. With SDR and anti-greenwashing rules now raising the bar significantly, it is only right that bringing the providers behind them within the regulatory perimeter is a sensible evolution of the market.”
But she adds: “As with any score-based disclosure, this new set of rules should not be interpreted as there being one objectively correct ESG score. ESG rating providers will continue to have differing methodologies, definitions and samples, and while they must disclose this, it is up to allocators to interrogate that data and not allow it to replace thorough due diligence.
“The final regime has kept that focus on transparency, but as the market develops we need to make sure the data being received translates into genuinely useful information for investors rather than disclosure for disclosure’s sake.”
Source: corporate-adviser.com
