ESG Ratings: FCA Proposed Approach to Regulation (CP25/34)

1. Who we are & why we are responding

The Society represents Members working for publicly listed companies and investor relations focused service providers, to assist them in the development of effective two-way communication with the markets. It has over 700 Members, drawn mainly from the UK, including the majority of the UK FTSE 100, many of the FTSE 250 constituents and some from AIM-listed companies, as well as those listed overseas. 

The Society’s mission is to promote best practice in investor relations; to support the professional development of its Members; to represent their views to regulatory bodies, the investment community and Government; and to act as a forum for issuers and the investment community. 

Our response has therefore been primarily constructed through the lens of a corporate issuer, and our response focuses on the aspects and questions in CP25/34 of most relevance to our members: Chapter 6, which sets out expectations for stakeholder engagement, data access rights and factual error correction.

We also append the findings from our member survey on ESG Data & Ratings, which underscore the importance of proportionality and the need to avoid unnecessary duplication of processes.

2. Overview

We strongly support the FCA’s objective of improving transparency, reliability and accountability in the ESG ratings market, and we are pleased that the FCA’s approach is well aligned with the Society’s previous feedback to HM Treasury on the need for greater transparency, structured issuer engagement, clearer governance expectations and strengthened management of conflicts of interest. 

From an issuer and IR perspective, there has been long standing demand for a framework that gives rated entities clearer visibility of methodologies, earlier sight of data used, and meaningful opportunities to correct factual inaccuracies. Many of the proposals — particularly advance notice of first time ratings, free access to the underlying data used in producing a rating, and the opportunity to correct factual inaccuracies before a rating is issued — represent a significant improvement on current practice.

However, three issues remain of particular and practical concern to issuers, set out overleaf:

EU/UK divergence and duplicated processes 
Even where high level policy intent of the UK and EU regimes is aligned, the FCA’s proposed principles based approach means that providers retain discretion over how stakeholder engagement is implemented. 

This means that, in practice, global rating providers may introduce differences in a number of areas, including:
•    pre publication notice periods;
•    windows to correct factual inaccuracies;
•    templates or formats for engagement;
•    interpretations of what constitutes a “material” methodology change; and
•    sequencing of engagement steps.

For issuers, this could translate into parallel, non aligned engagement processes for the same rating under UK and EU regimes. This could create duplicative issuer workload without improving data quality, and the burden of managing these differences falls directly on issuers and their IR/Sustainability teams. We therefore encourage the FCA to pursue maximum practical alignment at a process level (while recognising that providers’ proprietary methodologies will — appropriately — remain distinct), to avoid unnecessary duplication and reduce friction for rated entities.

Proportionality – ensuring small and mid cap issuers are not disadvantaged
The FCA proposes that providers give rated entities “sufficient time” to correct factual inaccuracies before publication and explicitly states that providers should take the size of the rated entity into account when determining what constitutes “sufficient time” (CP25/34 para 6.13).

This flexibility is welcome, but it is not a guarantee of proportionality, nor does the CP set clear expectations on:
•    minimum response timeframes or windows (or guarantee of additional time for smaller issuers);
•    simplified or pre populated data requests, or
•    proportional lighter touch ongoing engagement cycles for smaller issuers.

Many FTSE 250, Small Cap and unlisted companies operate with very limited ESG resource; in our 2023 Survey, 73% of IROs reported ESG data collection to be difficult or very difficult (see Appendix). Without expectations around proportionality, smaller issuers may struggle to manage repeated information requests, technical questions and short timeframes. 

We therefore encourage the FCA to strengthen proportionality signals in the final rules to improve fairness and workability across issuers of all sizes.

Gaps in the current proposals relevant to issuers
Two areas of practical importance to issuers that are not currently included in CP25/34:
•    Notification of rating updates or reassessments: The CP requires notification before a first rating is issued, but not for subsequent updates. This limits issuers’ ability to exercise their factual error correction rights in practice.
•    Access to full rating reports: The CP requires free access to the data used and the required minimum disclosures, but does not require providers to supply issuers with the full commercial rating report at no cost. We suggest the FCA ensures minimum disclosures are sufficiently detailed to allow issuers to understand the basis of their rating.

3. Answers to specific questions

Q15 – Stakeholder engagement
We support the proposed stakeholder engagement framework. Issuers particularly welcome the requirement for providers to:
•    notify rated entities before issuing a first rating,
•    provide access to the data used to produce the rating on request, and
•    give rated entities an opportunity to correct factual inaccuracies before publication, with the provider required to consider issuer size when determining what constitutes “sufficient time”.

Some members report that where ESG disclosures migrate from Annual Reports to corporate websites, rating providers do not always locate the updated materials, leading to avoidable factual error loops. Any encouragement from the FCA for providers to recognise common web based reporting structures, or to improve their processes for locating and interpreting companies’ online ESG disclosures, could help reduce such errors.

Three aspects of the proposals also require refinement:
 

Missing requirement: notification of rating updates:
The CP only requires notification before a first rating is issued. It does not require notification of updates or reassessments meaning issuers may be unaware when a rating changes and therefore unable to correct factual inaccuracies. Such updates may materially affect investor perception and capital allocation. We encourage the FCA to require providers to notify issuers of material rating changes, enabling them to exercise their factual error correction rights effectively.

Proportionality:
Although providers are expected to consider issuer size when determining what constitutes “sufficient time,” this is not a firm safeguard and the CP does not set expectations around minimum timelines or simplified requests. Clearer signals from the FCA that engagement timelines should be proportionate to issuer capacity would materially assist smaller issuers.

EU/UK divergence:
Global providers may adopt different UK and EU engagement processes, due to the principles based design of the FCA’s proposed regime, creating duplicated work for issuers. This includes potentially different notice periods, factual error correction windows, templates, and sequencing. We encourage the FCA to pursue practical alignment wherever feasible, to avoid issuers being required to manage parallel engagement processes for the same rating and help reduce unnecessary duplication. 

Q16 – Complaints handling
We agree with the requirement for a clear and accessible complaints procedure. This is particularly important in cases involving repeated factual inaccuracies or a lack of provider responsiveness. We encourage the FCA to reinforce that complaints procedures should require timely and transparent responses from providers and be proportionate and usable for smaller issuers with limited capacity to engage in repeated escalations,

Q17 – Implementation challenges
 

Yes, we anticipate two main challenges:
 

EU/UK divergence:
As mentioned above, differences in timing or structure between UK and EU engagement processes could require issuers to participate in duplicated engagement cycles for the same rating. Practical process alignment would help to mitigate this.

Issuer resourcing and proportionality:
As mentioned above, many issuers, particularly smaller ones, may face challenges meeting deadlines or managing repeated or technical data verification cycles. Stronger FCA guidance on proportionality and reasonable timelines would assist both providers and issuers in setting fair expectations.

We hope you find these comments useful. Please do not hesitate to make contact if you have any questions, and we look forward to ongoing engagement as these proposals are refined.
Yours faithfully

Liz Cole
Head of Policy and Communications, The Investor Relations Society
(Email: enquiries@irsociety.org.uk, Tel: + 44 (0) 20 3978 1980)

Appendix - Society evidence base relevant to CP25/34

Society ESG Data & Ratings IRO Member Survey 2023 - Highlights
The following headline findings are drawn from the Society’s 2023 survey of 88 member companies (FTSE 100, FTSE 250, Small Cap, AIM and unlisted):

1. ESG data burden
•    73% of IROs found internal ESG data collection difficult or very difficult.
•    Only 4% found it easy.

2. Workload related to ESG rating providers
•    70% reported that annual methodology changes make progress tracking difficult.
•    72% had engaged with an ESG rater regarding methodology.
•    70% had engaged regarding data errors.

3. Satisfaction levels
•    Only 24% were satisfied with the quality of ESG ratings analysis.
•    37% were dissatisfied or very dissatisfied.

4. Resourcing constraints for smaller issuers
•    Many FTSE 250 and Small Cap IR teams have one or no dedicated ESG/sustainability specialist.

5. Investor expectations
•    Over 80% believe ESG ratings are moderately to extremely important to their equity investors.
These findings underscore the importance of proportionality and the need to avoid unnecessary duplication of processes.
 

We also attach a PDF of the full report.