A new UK law aimed at regulating agencies that assess companies' environmental, social, and governance (ESG) performance is set to be introduced next year, according to an announcement by Rachel Reeves.

This initiative, part of a global effort to enhance transparency within the largely unregulated sustainable ratings industry, will address an industry that exerts significant influence over trillions of pounds in investments.

During her visit to Toronto, Reeves stated, “We are forging a new partnership with industry to get finance to the best, most innovative and most sustainable companies so that we can unleash Britain’s potential.” Her visit included meetings with leaders of Canada’s extensive pension fund industry and discussions on clean technology investments with Mark Carney, former governor of the Bank of England.

Reeves’ plan seeks to align UK legislation covering ESG rating agencies with standards in other leading economies, including the EU. This move builds on the work initiated by Jeremy Hunt, the former Conservative chancellor, which was not advanced before the Conservative party’s loss in the July 4 general election.

Currently, there is minimal oversight on how ESG criteria are established and how companies are rated against them. These ratings significantly influence which stocks and bonds are included in investment funds marketed as sustainable.

The UK Treasury began consulting with industry stakeholders about regulating rating providers in March 2023, with Hunt committing to regulation in his Spring Budget this year. Reeves has since decided that legislation is necessary and announced that a bill will be introduced next year.

Reeves expressed particular concern about the lack of transparency in the ratings process, noting that increased clarity would support the growth of Britain’s sustainable finance sector. Allies of Reeves also highlighted concerns about the "opaque" criteria used by rating agencies, which could result in unjustified divestment from UK defense companies.

The Financial Conduct Authority (FCA), the UK’s top financial regulator, will be tasked with setting the rules for the new regime, rather than creating a new watchdog. To minimize additional burdens on businesses, the UK’s approach will align with international recommendations and the system being developed by the EU.

Last year, the European Commission proposed new regulations for ESG rating providers, including the separation of data services from consultancy functions and greater transparency in methodologies.

Lorraine Johnston, head of ESG regulation at law firm Ashurst, noted that the consultation on the new regime closed in June 2023, emphasizing that the industry “desperately needs clarification” on the proposals, especially in light of recent requirements for UK funds to disclose their sustainability practices.

Lindsey Stewart, director of investment stewardship research at Morningstar, welcomed the increased "supervision over how ESG ratings are derived to drive the transparency investors need to make high-quality decisions.” However, Stewart cautioned against extending regulation beyond ratings, which he described as "opinions, which are often diverse," to ESG data, which he called the "objective" foundation of these ratings. He warned that restricting the flow of ESG data, particularly on "fast-emerging new topics," could adversely impact investors.

Source: HM Treasury, UK