Moves to give the UK’s financial watchdog oversight of how ESG ratings are awarded will ensure long-awaited consistency in the sector, according to an expert.
The new rules mean that, from June 2028, environmental, social and governance ratings providers will fall under the regulatory scope of the Financial Conduct Authority (FCA).
The government has now published draft legislation, originally announced in the 2024 Budget and following industry consultation (63-page / 567KB PDF), which will mark the first time ESG ratings have been subject to formal oversight, and mean any ratings provider – even beyond the UK – which serves clients in the country will also come under the FCA scrutiny.
The move marks the latest increase in the FCA’s authority on regulation, after the UK Treasury gave it oversight over the anti-money laundering enforcement of the professional services industry earlier this week.
ESG ratings represent a company’s risk of exposure to long-term environmental, social and governance issues, and can be used by investors as a guide to the firm’s risk management practices.
Hayden Morgan, an expert on sustainable finance and the use of ESG ratings at Pinsent Masons, said the move would bring improved transparency to the sector.
“This market has evolved based on a demand for insight to consider sustainability performance and assess future risks and opportunities which then is considered as part of fiduciary duty, and as part of an assessment of risk-adjusted financial returns when making capital allocation and investment decisions,” he explained.
“However for too long investors have been making these crucial decisions and trying to fulfil fiduciary duties based on opaque, black box methodologies - there is no consistency in the ESG ratings market.”
“Currently, different rating providers source variable data and apply inconsistent algorithms, resulting in rating outcomes which may, or may not, reflect past and future sustainability performance and associated financial performance and prospects of a company or financial instrument.”
“These proposals by the FCA reflect the desire for more transparency, and provided the regulation is proportionate, they should reduce greenwashing, allow investors to fulfil their duties, and allocate capital with improved clarity and trust in ESG ratings.”
The FCA said it welcomed the move, which marked a “significant milestone” towards enhancing transparency around ratings provision in the UK.
The agency said it had been developing its new regime for the ratings – focused on transparency, governance, systems and controls, and conflicts of interest, and planned to open a consultation before the end of the year.
“ESG ratings continue to play a critical role in influencing investment and capital allocation decisions,” it added.
“The legislation, which was broadly supported by the industry, will provide us with the necessary powers to regulate ESG ratings providers – an important step towards ensuring that there are transparent, reliable and comparable ESG ratings.
“This will support our work to enhance the UK’s reputation as a global hub for sustainable finance – attracting investment and supporting growth and innovation.”
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