Sustainable finance grows up
By Christopher Jones, Partner
The UK’s move to regulate Environmental, Social, and Governance (ESG) rating agencies, as recently announced by new UK Chancellor Rachel Reeves, could mark a significant moment in the pursuit of a more transparent, reliable, and effective sustainable finance sector.
Ratings agency assessment of the sustainability performance of companies has been much maligned in recent years, especially by those requiring enhanced clarity and accountability to a powerful but largely unregulated industry. This is in response to the profound impact that these agencies may have on directing investment, based on their individual assessments. Their judgements lack any oversight and little recourse for redress should their appraisals be inaccurate or formed upon outdated information of their choosing.
The current landscape
Today, ESG rating agencies operate with unregulated influence, with the potential to guide or restrict the flow of trillions of pounds into investments that they deem sustainable or not.
Despite efforts in certain quarters to enhance the transparency of their methodologies in recent years, many still consider the process opaque and one way (unless you’re willing to pay to engage) and have frequently led to inconsistencies and potentially misleading assessments.
The proposed UK legislation would seek to fortify the credibility of the ESG ratings market by setting stringent standards for transparency and reliability, much like the regulatory frameworks that have been taking shape through the EU’s Corporate Sustainability Reporting Directive and the International Sustainability Standards Board.
The proposed regulation
- Enhance Transparency: By requiring ESG rating agencies to disclose their rating methodologies and criteria, investors and stakeholders could better understand and trust the ratings assigned.
- Prevent Misleading Practices: Standardised regulations could curb the risk of agencies giving partial ratings based on unclear or biased criteria, which may lead to unwarranted divestments, notably from sectors such as UK defence.
- Align Globally: Matching steps with international standards could help to create a uniform global market for sustainable investments, facilitating smoother international cooperation and investment flow.
Challenges and Considerations
While the prospect of regulation may be welcomed for the potential to enhance market stability and investment quality, concerns linger regarding the breadth and depth of such regulations and not least the timing of assessments, when companies are adapting their initiatives – such as Net Zero roadmaps – in real time.
Corporates may demand the need to distinguish between regulating subjective rating opinions and the objective ESG data upon which these ratings are based. Excessive regulation could stifle the diversity of opinions and restrict the availability of ESG data, which is critical for informed decision-making in rapidly evolving sectors.
Conclusion
The integration of clear, fair, and enforceable regulations in the ESG rating sector could represent a strategic enhancement to the architecture of global finance. By ensuring that ESG ratings are both meaningful and reliable, the UK takes a decisive step towards maturing the perception of ethical investment practices.
If you are considering ESG ratings as part of your investor relations strategy, speak to our Sustainability team: [email protected]