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, giving rise to concerns over a conflict of interest.
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.
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 12 of the UK’s largest watchdogs to provide dozens of ideas for ways to pare back excessive or needless red tape on the private sector.
But the FCA estimated the 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 survey it conducted to assess investor demand.