Britain’s financial regulator is preparing to subject environmental, social and governance (ESG) ratings agencies to formal regulation for the first time, in what is being described as the most comprehensive overhaul of sustainable finance rules in the country’s history.
The Financial Conduct Authority (FCA) has launched a consultation outlining plans to oversee the fast-growing ESG ratings sector, which has become a $2.2 billion (£1.6 billion) global industry as investment managers increasingly integrate ESG criteria into their strategies.
Rating agencies evaluate companies and funds in terms of environmental impact, social responsibility and governance standards. However, the sector’s explosive growth has raised ongoing concerns about inconsistent valuation, opaque methodologies and potential conflicts of interest, particularly when rating providers also provide advisory services to the same companies they rate.
Under the FCA’s proposals, agencies would be required to disclose their methods and data sources and identify and manage any conflicts. The move follows warnings from investors and regulators worldwide that different ESG assessment practices are undermining trust in sustainable finance.
James Alexander, chief executive of the UK Sustainable Investment and Finance Association, welcomed the proposals. “We particularly welcome the emphasis on transparency and consistency with international standards,” he said, noting the consistency with previous recommendations from the International Organization of Securities Commissions (IOSCO).
The government decided to support FCA supervision despite the Chancellor and Prime Minister urging regulators to cut “excessive red tape” to boost economic growth. Last year, ministers wrote to key regulators calling for proposals to reduce regulatory burdens on businesses.
Still, the FCA says regulating ESG ratings could generate net benefits of £500 million over the next decade by reducing the due diligence costs that asset managers currently incur when comparing different rating methodologies.
The proposals appear to have broad industry support, with 95% of respondents to a government survey in favor of bringing ESG ratings under regulatory oversight.
Andy Ford, head of responsible investing at St James’s Place, said the regulation was a welcome step but cautioned against assuming it will solve all market challenges. “ESG ratings can vary from provider to provider because the methodologies vary,” he said. “Investment managers should not rely too heavily on third-party ratings. These should be one input among many, compared to internal analysis rather than outsourced assessments.”
The consultation will run until March next year, with final rules expected towards the end of 2026.
