UK Launches Proposed Law to Regulate ESG Ratings Providers

The UK government announced the publication of draft legislation, aimed at regulating providers of ESG ratings, with plans to proceed with introducing a finalized law to Parliament in early 2025. The new proposed law would place ESG ratings providers under the supervision of the Financial Conduct Authority (FCA).

The new draft legislation follows the launch of a consultation in early 2023 by the prior government assessing the need to regulate ESG ratings providers in order to improve clarity and trust in ESG ratings, as investors increasingly integrate ESG considerations into the investment process, while the activities and businesses of the providers are generally not covered by markets and securities regulators.

In November 2021, securities regulator standards setter IOSCO urged regulators to focus on improving transparency in the ESG ratings and data space, and to begin to apply regulatory oversight. IOSCO also provided a series of recommendations for regulators, such as requiring providers to identify and disclose potential conflicts of interest, and to consider the data and methodologies used by the providers.

Since IOSCO launched its recommendation, several jurisdictions have moved to increase oversight in the space, including the EU, where lawmakers recently agreed to bring ESG ratings providers under the authority of European markets regulator ESMA and to introduce rules to increase the reliability and comparability of ESG ratings and prevent providers’ conflicts of interest.

Alongside the launch of the draft legislation, the UK finance ministry, HM Treasury, issued its response to the 2023 consultation, which found broad market support for the regulation, with 95% of respondents – including 87% of ratings providers themselves – agreeing that regulation should be introduced for ESG ratings providers.

Key regulatory requirements supported by respondents included improving transparency in the methodologies behind ESG ratings, and addressing conflicts of interest.

Under the proposed legislation, ESG ratings providers would be required to become authorized by the FCA, and meet a series of conditions an assessment of the providers’ supervisory effectiveness, business model, and other requirements. The regulations would apply both to “ratings produced in the UK and ratings produced overseas which are made available to UK users by way of a business relationship.”

The government’s consultation response outlined an anticipated four-year process for the launch of the ESG ratings regulatory regime, with legislation expected to be introduced in early 2025, followed by the development and consultation of policy proposals for the regulation by the FCA, after which affected firms will go through the authorization process, with the regime then going live.

The proposal also outlines exclusions from regulatory coverage for some ESG ratings providers, such as credit ratings and investment research providers that are already covered by FCA regulation that provide ESG ratings as part of existing activities, and not as a standalone rating.

In the consultation response, Tulip Siddiq, Economic Secretary to the Treasury & City Minister, said:

“With the global ESG market predicted to surpass $40 trillion by 2030, investors and markets are making increasing use of ESG ratings to inform investment decisions and capital allocation. Bringing ESG ratings providers into regulation will boost investor confidence, reduce greenwashing, and address the lack of transparency highlighted in responses to the government’s consultation. This will help to drive investment, support innovation and ensure that companies in critical sectors are not penalised by opaque ratings.”

Click here to access the draft legislation.