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A new UK law to regulate agencies that evaluate the environmental, social and governance performance of companies is to be brought forward next year, Rachel Reeves has announced.
The chancellor’s crackdown on the sustainable ratings industry — a largely unregulated sector that wields broad influence over trillions of pounds’ worth of investments — is part of a global drive to increase transparency of the sector.
Reeves, on a visit to Toronto, said: “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.”
Reeves was in Toronto to meet bosses of Canada’s huge pension fund industry and to discuss clean technology investment with Mark Carney, former governor of the Bank of England.
As part of her drive to raise Britain’s growth performance, Reeves wants to bring UK legislation covering ESG rating agencies into line with other leading economies, including the EU.
Her plan takes forward work started by Jeremy Hunt, former Conservative chancellor, but not presented before his party lost the July 4 general election.
At present there is little oversight on how organisations create ESG criteria and rate other companies against them. The ratings influence which stocks and bonds make it into investment funds that are marketed as sustainable.
The Treasury began consulting industry about regulating rating providers in March 2023 and Hunt promised to regulate the sector in his Spring Budget this year. Reeves has decided that legislation is needed and said she would bring forward a bill next year.
She said she was particularly concerned about the lack of transparency in the ratings process and that clarity would help sustain Britain’s efforts to develop its sustainable finance sector.
In particular, allies of Reeves said she was concerned that “opaque” criteria used by the agencies could lead to unwarranted divestment from UK defence companies.
Reeves has decided that the Financial Conduct Authority, the top financial regulator, will set the rules of the new regime; there had been suggestions a new watchdog might be created to administer the regime.
To avoid new burdens on business, the UK regime will mirror international recommendations and the system being created by the EU.
The European Commission proposed new rules for ESG rating providers last year, including separate ratings groups’ provision of data services from their consultancy arms.
The bloc’s executive arm also asked them to disclose more methodological details and to formally register with authorities.
Lorraine Johnston, head of ESG regulation at law firm Ashurst, said the consultation on the new regime had closed in June 2023 and the industry “desperately needs clarification” on the proposals because of requirements introduced last week for UK funds to make disclosures about their sustainability.
Lindsey Stewart, director of investment stewardship research at data and index provider Morningstar, welcomed the prospect of more “supervision over how [ESG] ratings are derived to drive the transparency investors need to make high-quality decisions”.
But he warned the government against going beyond regulating the ratings, which he described as “opinions, which are often diverse”, and regulating ESG data, which he said was the “objective” facts upon which ratings were calculated.
Restrictions on the flow of ESG data, which encompasses “fast-emerging new topics”, could negatively affect investors, Stewart added.
Additional reporting by Michael O’Dwyer in London