In a landmark move to bolster transparency and accountability in sustainable finance, the UK government has announced plans to regulate Environmental, Social, and Governance (ESG) ratings providers. This initiative aims to address concerns over inconsistent methodologies and potential conflicts of interest in ESG assessments, which are increasingly influential in investment decisions.
The proposed regulation, outlined in a draft Statutory Instrument, will bring ESG ratings providers under the supervision of the Financial Conduct Authority (FCA). This aligns with international standards set by the International Organisation of Securities Commissions (IOSCO) and mirrors similar regulatory efforts in the European Union. The FCA has expressed strong support for this move, emphasising the need for improved transparency and trust in the ESG ratings market.
A consultation conducted by HM Treasury revealed overwhelming support for the regulation, with 95% of respondents endorsing the initiative. Stakeholders highlighted the necessity of clear methodologies, regular reviews, and transparency to eliminate 'black box' practices in ESG ratings. However, concerns were raised about the potential impact on smaller providers, with some fearing that stringent transparency rules could stifle innovation and impose disproportionate compliance costs.
The regulation will apply to both domestic and international ESG ratings providers offering services to UK users, ensuring a level playing field and preventing regulatory arbitrage. The government is also considering the establishment of an overseas ESG ratings regime as an alternative to requiring full UK authorisation for non-UK providers.
The draft legislation is open for technical feedback until 14 January 2025, with the full regulatory framework expected to be operational within four years. The FCA will oversee the development and consultation of specific rules and guidance, ensuring alignment with international standards and thorough cost-benefit analysis.
This regulatory development positions the UK at the forefront of sustainable finance, aiming to enhance the credibility of ESG ratings and support the growth of responsible investment practices.
