In August, chancellor Rachel Reeves confirmed that she would continue the previous government’s plan to regulate the sustainability ratings industry.
Also known as environmental, social and governance benchmarking, this is a growing industry that provides ratings on ESG in respect of firms and products.
These plans have been bubbling away for some time, including in a consultation from the Financial Conduct Authority in June 2021 and the government in 2023.
The announcement indicates that the new government intends to move on from the current voluntary code of conduct, which was considered by some to be a stopgap pending legislation in this area.
Focus of ESG benchmark regulation
Both the voluntary code and 2023 consultation identify transparency of methodology and conflicts of interest as key concerns in respect of ESG benchmarking.
This focus is likely to be carried through into any new regulatory measures and will also, it appears, continue to seek to align with the EU and other international ESG regulatory regimes.
The FCA has also recognised in its 2021 consultation that ESG ratings firms are not suited to a one-size-fits-all approach, noting that different rating providers may have good reasons to adopt different methodologies and must grapple with incomplete data sets.
The 2023 consultation indicates that a new regulated activity of “providing an ESG rating to be used by a person in the UK in relation to an RAO specified investment”, (that is, to be used in relation to financial products already regulated by the FCA) will be introduced.
The paper also reports that, as the industry might expect, should ESG benchmarking be brought within the FCA’s regulatory perimeter, the FCA will consult further before implementing specific rules.
Any future consultation will have to grapple with when an ESG rating has been produced “to be used… in relation to” regulated investments, and the degree to which ratings firms should be aware of, and responsible for, onwards use of their product.
The prevailing trend
The chancellor’s announcement reflects a wider trend. The regulator and other public authorities are under significant pressure to show that they are taking effective action with respect to ESG issues.
The most striking example of this is claims brought by legal activists against public bodies, including that brought against the National Crime Agency by the World Uyghur Congress concerning criminality in supply chains, and ClientEarth’s unsuccessful judicial review of the FCA concerning the listing of an oil and gas explorer and disclosure of climate risk.
It is, therefore, unsurprising that the FCA has made ESG a key strategic priority in its most recent business plan and has started to take action in this area.
In May 2024, its sustainability disclosure and labelling regime (widely known as the green-washing rules) came into force. These concerned the quality and clarity of information disclosed by regulated firms in respect of ESG-focused products.
