With the introduction of new regulation, voices from the sustainable investment industry urged Reeves to ensure she does not stymie competition or growth. || Credit: HM Treasury
Pressure has begun to mount on chancellor Rachel Reeves from the sustainable investment industry ahead of the introduction of secondary legislation to regulate ESG rating agencies next year.
Earlier this month (8 August), Reeves asked her office to "respond quickly to an industry consultation on a new regulatory regime for ESG rating providers and bring forward legislation next year", a Treasury spokesperson said.
Since taking charge of Britain's purse strings, Reeves has expressed a desire to "drive more investment and cement the UK as a world leader in sustainable finance", the Treasury said, with the lack of transparency behind ESG ratings top of the chancellor's list of priorities.
The case for clarity
"The aim of increasing transparency is something that I can fully, fully get behind," said Paris Jordan, head of responsible investing at Charles Stanley.
Jordan also said that currently some ESG rating agencies dominate the market of ESG decision making with a lack of recourse in place.
"I think there has been a recognition that the rating agencies need some guardrails," she added. "If you do not explain what goes into any form of process, and the outcome differs from what the client expected, you are going to end up in trouble."
Rachel Reeves to bring in legislation to regulate ESG rating agencies
Calls for greater clarity were echoed by RepRisk's chief commercial officer Alexandra Mihailescu Cichon, who said: "Transparency is the critical thing.
"There is an estimated $33trn under this umbrella of ESG investments and the scores that are used to build those ESG funds and ESG portfolios are based on the ESG ratings."
Like many across the industry, Cichon urged the government to address the "level of opaqueness and the black box methodology" that currently exists so that investors can rest assured that the funds are having the desired impact.
Reeves' proposed legislation seeks to provide improved clarity of how organisations formulate barometers of ESG ratings and value companies against them.
These ratings are then integral for influencing the stocks and bonds which compose investment funds that are presented to investors as ‘sustainable'.
This follows consultation that the Treasury embarked on in March 2023 which informed a commitment by the previous chancellor Jeremy Hunt to regulate the sector in his Spring Budget earlier this year.
UK to outline regulatory rules for ESG ratings industry as early as January 2024
While Reeves has not provided detailed information on what will be included in the Bill, it is expected that the incoming legislation will reflect European Union regulation.
"We understand that both the EU and the UK are after the same kind of goals," said Arthur Carabia, director of ESG policy research at Morningstar Sustainalytics, one of the major ESG rating providers.
These goals include the implementation of core recommendations to "safeguard methodological independence", Carabia said.
Do not halt growth
However, with the introduction of new regulation, voices from the sustainable investment industry urged Reeves to ensure she does not stymie competition or growth.
"When regulating you want to make sure that you do not overdo it to a point of actually impeding ESG analysis or restricting competition," noted Carabia.
Ninety One's sustainability director Daisy Streatfeild argued the importance of developing understanding of ESG risks to improve competition and improving methodologies for verifying data, highlighting: "Regulation that inadvertently thwarts these developments will not serve the market in the long term."
Third-party ratings are increasingly used as a basis for investment decisions, meaning "rating providers are becoming movers of markets", she said.
As the importance and financial gravitas of these rating agencies increases, Streatfeild stressed regulation to increase transparency "is not a silver bullet".
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"It is not possible to regulate away complexities in understanding ESG risks and impacts; these can only be addressed through ongoing detailed analysis of information, and corporate policies and plans in relation to these issues," she added.
What is more, "there is no one-size-fits-all" approach to regulation, according to Charles Stanley's Jordan, who urged the Treasury not to standardise an opinion of ‘sustainability' when formulating policy.
The Treasury spokesperson noted: "The new approach will boost growth, help deliver a cleaner economy and ensure that companies in critical sectors like defence are not penalised by opaque ratings," but declined to comment any further on the clamouring for increased clarity from the sustainable investment industry.
