UKSIF response: FCA CP25/34- ESG ratings: proposed approach to regulation

We believe the proposed measures in the consultation have the potential to enhance users of ESG ratings and wider stakeholders’ understanding and trust in these products, though our response sets out various recommendations for consideration from the regulator.

In our view, these recommendations would advance competition and innovation in the UK’s ESG ratings market, the practical operation of the UK’s regulatory regime for different market participants and stakeholders, and support the delivery of positive outcomes for users of ESG ratings, service providers, and financial markets at large.

Executive summary – main points in UKSIF’s response

• Support for the direction of travel of the consultation proposals: Broadly speaking, we are supportive of a number of the consultation’s main proposed measures. This includes the overall balance and details of the criteria set out under the ‘two-layer’ approach to disclosure, as part of the proposed transparency requirements for ESG ratings providers. We also welcome the wider rules highlighted on governance, internal systems, and conflicts of interest, and the application of the baseline standards to ratings providers.
• Maintaining competition and dynamism in the UK’s ESG ratings market: With that said, we recommend that FCA actively considers additional proportionate measures to support the role of smaller ESG ratings providers under the UK’s regulatory regime. This is a particular consideration as the ESG ratings market continues to evolve and mature. We believe this approach would bring tangible benefits to the UK’s ESG ratings market, users of ratings products, and rated entities, and be consistent with the regulator’s existing statutory operational objectives. While we recognise some challenges in adopting tailored measures for smaller, specialist providers, we outline various areas for exploration to support this specific group. This includes in relation to the regulator’s authorisations process and UK presence requirements. Also, we recommend inclusion of a defined ‘review period’ (e.g. after 3-4 years) for the regulator to assess the impacts of requirements on smaller providers and market competition. There may be lessons to be drawn from the European Union’s proportionality measures for smaller firms in time, as its regulatory framework beds in.
• Enhancing comparability in disclosures for users of ESG ratings: In relation to the transparency requirements, we would welcome high-level guidance on the envisaged presentation, length, and format of the minimum public disclosures and additional private disclosures. This would have the objective of supporting comparability and usability across ESG ratings providers’ disclosures. The regulator should consider encouraging industry-wide collaboration to develop a voluntary, ‘fund factsheet-style’ template for the minimum public disclosures. This could enhance the comparability in product-level information, by guiding users in assessing differences between products’ objectives, methodologies, assumptions, weightings, and ESG data coverage. As part of this, it would be useful to consider interoperability with similar template approaches in overseas jurisdictions, such as the EU. On the minimum public disclosures, the disclosure of ESG data estimates (where used) should be incorporated in this specific layer, with a baseline summary of a provider’s approach to data estimates valuable to include.
• Targeted changes to the ‘notification requirements’: We suggest several changes aimed at improving the operation of the notification framework, which we recognise is among the most challenging areas of the consultation. In our view, this includes confirmation that a prolonged period of delay and de-facto ‘veto right’ is not envisaged by rated entities on an ESG ratings provider’s assessment. Also, the FCA should provide indicative examples of what constitutes an ‘appropriate’ notice period from a provider to entities to clarify the rules. We believe refinements in this area of the consultation would minimise the risks of added reporting burden, especially for smaller ratings providers. There will be lessons to be drawn from the EU’s notification framework- one initial reflection is the two working-day window has been too short and led to challenges for market participants, particularly smaller rated entities.
• Treatment of asset managers’ internal ESG ratings: We would welcome clearer confirmation in the final policy statement that asset managers’ internal ESG ratings remain largely outside the scope of the UK’s regime. Further illustrative examples should be set out for when exclusions would apply. One envisaged example is where a fund manager discloses its use of a proprietary, internal ESG rating within product disclosures, or investor communications, for a labelled fund under the FCA’s Sustainability Disclosure Requirements (SDR) regime. Duplicative rules impacting this group, and institutional investors at large, should be minimised as far as possible, given the requirements for example outlined in the SDR and EU Sustainable Finance Disclosure Regulation (SFDR).
• Additional clarification for overseas-based ESG ratings providers: Further clarification would be beneficial for third-country ratings providers in relation to the upcoming authorisations process and long-term market access. This should aim to ensure that investors and other users of ESG ratings can continue to access ratings products and related products from non-UK based providers in a seamless manner, and without adding undue costs in the process for all groups. In relation to smaller ratings providers, it will be especially important to consider the authorisations process, making sure this does not pose a significant barrier to entry.
• Interaction with the voluntary UK Code of Conduct: We would very much welcome consideration by FCA and the International Capital Market Association (ICMA) over the future of the existing voluntary Code of Conduct and how it is envisaged to operate coherently alongside formal regulation. The interaction between the two initiatives will be very important in promoting clear expectations from policymakers to ESG ratings providers, users, and rated entities in the UK market. One option to maintain the voluntary UK Code’s ongoing relevance in the market in the longer-term would be to refocus its existing principles on ESG data products, given the regulation’s primary focus on ratings. As scrutiny of managers’ internal ESG ratings continues to evolve, a voluntary Code-based approach could be explored for this area of the UK’s market.

These recommendations draw on perspectives from across our membership network, which includes institutional investors as well as ESG data and service providers. We hosted a number of private member roundtables with both these groups to inform our response, though this does not necessarily reflect the views and perspectives of our entire membership, either individually or collectively.

Read More