Society responds to the ESG data and ratings HM Treasury Consultation
In this IR Society response, which draws on the findings from recent IRO member research on ESG data and ratings, which underline the importance of ESG ratings to corporates, illustrate a level of dissatisfaction with the quality of engagement between companies and ratings agencies, and indicate strong support for their regulation (90% of respondent IROs think they should be regulated by the FCA). The response also: • recommends that the UK regime is based on recommendations from IOSCO, to avoid regulatory arbitrage across jurisdictions; • calls for consistency and harmonisation with overseas equivalent regulations eg the EU’s recently published Proposal for regulating ESG ratings providers; and • recommends an appropriate transitional period, a phased approach so that smaller agencies have a longer transition period and an ongoing initial ‘start up’ period for new providers.
The Investor Relations Society
5th Floor, 30 Coleman Street
London, EC2R 5AL
By email: ESGRatingsConsultation@hmtreasury.gov.uk
30th June 2023
Dear Sir, Madam,
ESG data and ratings HM Treasury Consultation
Thank you for giving us the opportunity to comment on the proposed reforms set out in HM Treasury’s Consultation on Future regulatory regime for Environmental, Social, and Governance (ESG) ratings providers. This response is on behalf of the UK’s Investor Relations Society (‘the IR Society’).
The IR Society represents members working for publicly listed companies and consultancies to assist them in the development of effective two-way communication with the markets and to create a level playing field for all investors. It has approaching 800 members, drawn mainly from the UK, including the majority of the UK FTSE 100 and many of the FTSE 250 constituents, but also including some from companies listed overseas.
The IR 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. As such, our response has been primarily constructed through the lens of an issuer, rather than from an institutional investor/user perspective.
In formulating our views, we have drawn upon both the expertise and experience of our Policy Committee, but also the insights from a recent survey that we carried out among our IRO members to better understand their experiences with ESG data and ratings providers. We attach the findings from that member survey, which underline the importance of ESG ratings to corporates, illustrate a level of dissatisfaction with the quality of engagement between companies and ratings agencies, and indicate strong support for their regulation (90% of respondent IROs think they should be regulated by the FCA). We also refer to our findings where relevant in our response below.
We outline our other main points below:
- We recommend that the UK regime is based on the recommendations from IOSCO, to avoid regulatory arbitrage across jurisdictions (see Q1).
- We believe there is a need for consistency and harmonisation with overseas equivalent regulations eg the EU’s recently published Proposal for regulating ESG ratings providers (see Q3).
- We recommend an appropriate transitional period, and a phased approach so that smaller agencies have a longer transition period (see Q4). We also suggest consideration of an ongoing initial ‘start up’ period for new providers, during which they could be able to opt in (see Q4, Q17 and Q19).
- Do you agree that regulation should be introduced for ESG ratings providers?
Yes, we agree that regulation should be introduced for ESG ratings providers. The IR Society conducted a recent survey among our IRO members, and the results indicate overwhelming support for the introduction of regulation for ESG ratings providers. We attach the research findings, which show that 90% of respondent IROs believe the FCA should regulate ESG data and rating providers (to improve, for example, their transparency, governance and conflicts of interest).
The research also found that, whilst 85% of respondent IROs think a good ESG rating is important to their reputation, only 24% are satisfied with the analysis undertaken by ESG ratings agencies (of the remainder, 37% are dissatisfied and nearly 40% were neither satisfied or dissatisfied). FTSE250 IROs appear least satisfied with ratings agencies, with 85% of FTSE 250 respondent IROs dissatisfied or very dissatisfied. Over 70% of respondent IROs find the annual updates to ESG ratings agencies’ methodology make it difficult to do historical analysis and monitor progress.
To provide some examples, we refer below to some of the verbatim comments made by our survey respondents outlining the issues they have experienced when dealing with the ratings agencies.
- “Our experience is that investors have gradually realised that there are huge inconsistencies in ESG analysis between different ratings agencies, and many have therefore developed their own methodologies rather than relying on external ratings. From a company perspective, we see a huge range of different approaches which makes it very difficult to understand the expectations, methodologies, and ultimately the ratings, across different ESG ratings providers.”
- “Very difficult to engage with most providers, methodology is notoriously opaque”
- “Frustrating lack of willingness to engage”
- “Rating agencies sometimes take an absolute approach to ESG. Sometimes this is difficult to navigate, especially when not all issues are material to our business.”
- “[a rating agency’s] sector categories are so broad that we were being captured alongside very different businesses (e.g. large international asset managers and global banks) where the ESG risks and opportunities are completely different. Following engagement, our sector categorisation was changed to something slightly more appropriate, but it is still a very broad category which we do not believe is appropriate in some areas.”
To minimise the risk of incompatible overlapping regulation across international jurisdictions, we recommend the UK (and overseas) regimes are based on the recommendations from IOSCO (International Organisation of Securities Commissions), which focus on ensuring transparency in methodologies, rather than attempting to prescribe any particular ESG assessment methodologies.
2. (For ESG ratings providers) If your firm were subject to regulation in line with IOSCO’s recommendations, and aimed at delivering the four key regulatory outcomes in Figure 1.A, how would this impact your business? Please provide information on the size of your business when answering this question.
No comment, question aimed at ratings providers.
3. Are there any practical challenges arising from overlap between potential regulation for ESG ratings providers and existing regulation?
Given several of the proxy agencies also provide ESG ratings, consideration should be given to how any new regulations will fit with the existing requirements for proxy voting agencies. (For example, the Proxy Advisors (Shareholders’ Rights) Regulations 2019 require them to disclose methodologies, voting policies, quality assurance procedures and conflicts of interest).
We are also aware of overseas regulation of ESG ratings, for example the EU’s recently published Proposal for regulating ESG ratings providers to enhance the integrity, transparency, responsibility, good governance and independence of ESG rating activities (see relevant extracts in the Appendix below). These EU rules could have extra-territorial scope (for example, the current EU Proposal is that they apply to ratings made public in the EU, which presumably could then be accessed/used by UK-based users and thus such ratings would be caught under both the UK and EU regimes) so it is important that the UK rules can dovetail with these and be consistent with them.
Where ESG Ratings providers also provide consultancy services to investors and/or corporates, this creates a clear conflict of interest that needs to be dealt with under the regulatory framework. To address this issue, the regulatory regime should at least require conflicts to be disclosed, and potentially should go beyond that by requiring internal separation of activities, for instance by requiring information sharing protocols between the ratings and consultancy departments. A requirement for full transparency of services provided to investors/corporates might be introduced as a first step given that internal separation may take time to achieve. We note that the EU Proposal would also require separation of ESG Ratings from provision of consultancy services to investors, credit ratings, benchmarks and investment, audit, insurance or banking activities (see Article 15) and there could be benefit in aligning the UK regime with other regimes such as with the EU.
4. Are there any other practical challenges to introducing such regulation?
We recommend that HM Treasury introduces an appropriate transition period and also adopts a phased approach, under which larger agencies would be brought within the new regulations earlier, given their resources and capacity to develop best practice. Smaller agencies could be given a longer transition period due to potential resource limitations. By allowing for phased implementation, the regulatory burden can be managed more effectively. We note the EU Proposal would require applications for authorisation to be made within 6 months of the law coming into effect for larger entities, with existing small/medium sized entities having 24 months from the date of the regulation (Article 48). Under the EU Proposal, any new small/medium sized entities would be required to apply for authorisation within 12 months of starting to provide the services (see Article 48). We also suggest consideration of an ongoing initial ‘start up’ period for new providers to help promote competition and innovation, akin to the EU Proposal.
It is important for HM Treasury to consult with ESG ratings providers to determine what would be appropriate time frames for the transition period and consider their expertise in proposing suitable phasing arrangements.
Another aspect that HM Treasury needs to consider in due course is the enforcement of these regulations, ie the need to determine appropriate consequences for breaching these new regulations and identifying which bodies will be responsible for monitoring and implementing sanctions.
Description of ESG ratings and their provision
5. Do you agree with the proposed description of an ESG rating?
Subject to our comments at Q5-Q9 below, the proposals covered in this chapter all seem sensible and we are not aware of any circumstances in which ESG ratings that do not relate/pertain to RAO specified investments could give rise to issues that would benefit from regulation.
6. Do you agree that ESG data, where no assessment is present, should be excluded from regulation?
Regarding the exclusion of ESG data providers from regulation, there are differing opinions among our members.
Some members expressed concern about excluding data providers from this regulation, as the proposal is not only to exclude unprocessed raw data, but also to exclude ‘minimally processed’ data, for example, that has been subject to formatting, summarising or adapted to include estimates to fill gaps in a data set, where transparency is needed. There are also concerns with excluding unprocessed raw data because, whilst there is no separate assessment provided, there can still be judgment involved in data gathering and presentation. We are also aware that some of our corporate members experience issues with the accuracy of ESG data presented as the corporate’s own data, so some members would argue that data providers should be included to improve their source transparency and accuracy. To provide some examples, we refer below to some of the verbatim comments made by our survey respondents outlining the issues they have experienced regarding accuracy of ESG data:
- “The data capture and accuracy of the data was poor from a number of agencies. Engaging with them (as well as improving our practices) resulted in a significant improvement.”
- “Usually we can review the information they have before it goes public. Sometimes they publish something we disagree with and if it's fact-based and material we will engage with them”
However, other members consider that, given there is less judgement involved, it is appropriate for ESG data providers to be excluded on the basis that market forces will encourage them to follow the voluntary code of conduct being developed by the ESG Data and Ratings Code of Conduct Working Group | IRSG (see para 2.8 in the consultation), which is expected to be in line with the IOSCO recommendations. This should help to ensure the accuracy and reliability of the data they produce and their transparency, for example, so that they specify their sources, which should be from public sources.
Our survey did not specifically ask for views about the possible future regulation of data providers (we asked about regulation of ratings providers and data providers together). As mentioned above, the survey found that 90% of respondent IROs believe the FCA should regulate ESG data and rating providers to improve, for example, their transparency, governance and conflicts of interest.
We note the EU Proposal excludes the provision of raw ESG data that does not contain an element of rating or scoring, and is not subject to any modelling or analysis resulting in the development of an ESG rating (Article 2(2)(c)). We believe the FCA should consider the benefits of aligning with the EU regime, and if the FCA decides to exclude any categories of data providers, they could then either be subject to the Designated Activities Regime (DAR, see para 1.20 in the consultation) or follow the voluntary code of conduct (see para 2.8 in the consultation).
7. Do you agree with the proposal to regulate the activity of providing ESG ratings to be used in relation to RAO specified investments?
As mentioned at Q5 above, we are not aware of any circumstances in which ESG ratings that do not relate/pertain to RAO specified investments could give rise to issues that would benefit from regulation and we therefore support this proposal.
In our view, the regulatory/ geographical scope should not be limited to UK instruments only, as this may impede the ability of UK companies to obtain ESG ratings, which could impact their ability to attract investors.
By way of background, RAO specified investments refer to investments that fall within the scope of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO), which provides a list of specified investments that are subject to regulation in the UK. These investments include various financial instruments such as shares, debentures, options, futures, contracts for differences, and units in collective investment schemes, among others. NB The term "RAO specified investments" is not limited to UK-based assets. It encompasses a wide range of financial instruments and activities that are subject to regulation under the RAO framework within the UK financial services industry. Therefore, this is not limited to UK-listed shares, ie shares of companies listed overseas can be included in RAO specified investments regardless of whether the companies are listed in the UK or overseas. The RAO regulations apply to activities related to these investments, such as dealing, arranging deals, advising, or managing investments, within the scope of the UK financial services regulatory framework.
8. (For ESG ratings providers) Do you know when an ESG rating you provide will be used in relation to a specified investment?
No comment, question aimed at ratings providers.
9. Are there ESG ratings used in relation to anything other than an RAO specified investment which also should be included in regulation?
10. Do you agree that each of the eight scenarios listed above (in paragraphs 3.2, 3.3, and 3.5) should be excluded from regulation? The exclusions set out in the consultation paper are:
• Credit ratings which consider the impact of ESG factors on creditworthiness, which are already subject to requirements under the Credit Ratings Agencies Regulation.
• Investment research products, such as equity research reports. These are established products which may incorporate ESG considerations, but which are different to the ratings of only ESG matters which HM Treasury wants to capture.
• External reviews, including second-party opinions, verifications, and certifications of ESG-labelled bonds. These activities can raise some of the same issues as ESG ratings but may benefit from different requirements which are more tailored to the provision of assurance-like activities in a non-audit capacity.
• Proxy advisor services, such as voting or recommendations to shareholders of firms. Recommendations by proxy advisors, even if related to ESG matters, are provided for a specific purpose (informing shareholders) and therefore should not be subject to the same regulation as ESG ratings. Some of these services are also already regulated by the FCA, which appears to be more appropriate mechanism.
• Consulting services, even where these relate to ESG matters. That is on the understanding that, if consulting services involve ESG ratings, these are often bespoke and ad hoc reviews, rather than ratings which systematically influence capital allocation. However, certain scenarios which are more likely to impact capital allocation, such as when a one-off ESG rating is provided for the purpose of an Initial Public Offering (IPO), should be subject to regulation.
• Academic research or journalism, even where that relates to ESG matters. Those are distinct activities which should not be subject to financial services regulation in this case.
Regarding Proxy advisor services, such as voting or recommendations to investors, we agree that these should be excluded, provided that any underlying ESG ratings that they use or rely upon in order to provide those services would be subject to this regulation. In our view, even where these ESG ratings are generated internally within the proxy advisor firm and are not made public, they should be regulated if they influence voting recommendations as the methodology for ESG ratings included in proxy reports should be clear.
We note that in the consultation paper (para 3.2) HM Treasury also proposes that the provision of ESG ratings by not-for-profit entities would be exempt from authorisation and regulatory requirements under the new regime. In our view, there should be an element of “best practice” principles for non-profits, under which they would follow the same principles in terms of transparency and governance, for example this could be pursuant to the voluntary code of conduct currently being developed (see para 2.8 in the consultation), under the proposed Designated Activities Regime (DAR, see para 1.20 in the consultation) that would not require FCA authorisation, or under the ‘opt-in’ approach for full FCA authorisation. There is currently insufficient information on each of these options for us to comment on which would be most appropriate. By way of an example from this sector, HM Treasury need to consider whether/how the World Benchmarking Alliance (WBA) that produces scorecards based on amalgamated standards should be dealt with under the new regulatory regime.
11. Are there any other exclusions which should be provided for?
Please see Q10 above.
12. Do you agree with the proposal to regulate the direct provision of ratings to users in the UK, regardless of the location of the provider?
As mentioned at Q1 above, the UK regime should be based on the recommendations from IOSCO, to avoid or mitigate regulatory arbitrage across jurisdictions (see Q1), and as mentioned at Q3 above, harmonisation and consistency should be maximised with equivalent overseas regulations eg the EU’s recently published Proposal for regulating ESG ratings providers.
13. (For UK users of ESG ratings) Are you concerned that this proposal would hamper the choice of ESG ratings available to you?
No comment, question aimed at ratings users.
14. Should any instances of direct provision of ESG ratings to users in the UK be excluded from regulation (for example, the provision of ESG ratings to UK branches of overseas firms, or to retail users who are temporarily physically located in the UK)?
No comment as this question examines issues for ratings providers/users.
15. Are there any scenarios of indirect provision of ESG ratings to UK users which should also be regulated?
No comment as this question examines issues for ratings providers/users.
16. How would the territorial scope proposed in this chapter interact with initiatives related to ESG ratings in other jurisdictions, such as proposals for regulation or codes of conduct?
As mentioned at Q1 above, the UK regime should be based on the recommendations from IOSCO, to avoid or mitigate regulatory arbitrage across jurisdictions (see Q1), and as mentioned at Q3 above, harmonisation and consistency should be maximised with equivalent overseas regulations eg the EU’s recently published proposal for regulating ESG ratings providers.
As mentioned at Q7 above, in our view, the geographical scope should not be limited to UK instruments only, as this may impede the ability of UK companies to obtain ESG ratings, which could impact their ability to attract investors.
17. Should smaller ESG ratings providers be subject to fewer or less burdensome requirements?
Regarding whether smaller ESG ratings providers should be subject to fewer or less burdensome requirements, there are differing opinions among our members.
Some members consider that smaller ESG ratings providers could be subject to a more proportionate regulatory regime (such as the proposed Designated Activities Regime (DAR) that would not require FCA authorisation - see para 1.20 in the consultation) to encourage competition and innovation, on the basis that they are less influential given the dominance of the big players.
However, other members believe that standardisation is necessary for the market, and that allowing a lighter touch regime for smaller providers might hinder this objective.
On balance, we would support the inclusion of smaller entities within the full FCA authorisation regime, as this would provide a level playing field. However, we suggest at Q4 above a longer transitional period for compliance and, to help promote competition and innovation, we also suggest at Q4 above consideration of an ongoing initial ‘start up’ period for new providers, akin to the EU proposal. We also suggest at Q19 below that smaller providers are able to opt in during any such transitional/start up period.
We note that, in addition to the longer (24 month) initial transitional period and the ongoing initial 12 month ‘start up’ period for new providers mentioned above, the EU Proposal would:
- allow ESMA to exempt smaller ESG rating providers from a number of organisational/ governance requirements where they meet certain criteria – see Article 14.
- supervisory fees should be proportionate to the annual net turnover of the ESG ratings provider concerned – see Article 40.
and we would suggest consideration of these measures for the UK regime.
18. (For ESG ratings providers) What impact would an authorisation requirement have on your business? Please provide information on the size of your business when answering this question.
No comment, question aimed at ratings providers.
19. Do you have any views on an opt-in mechanism for smaller providers?
As mentioned at Q4 and Q17 above, on balance we would support the inclusion of smaller entities within the full FCA authorisation regime, but with a longer transitional period for compliance and with an ongoing initial ‘start up’ period for new providers.
We would suggest that smaller providers are able to opt in during any such transitional/start up period, as market forces may cause users of their services to favour the regulated product and thus drive earlier ‘opt in’ to the authorisation regime.
20. What criteria should be used when evaluating the size of ESG ratings providers?
We do not believe that turnover and Balance Sheet are the correct measure for smaller providers, as it seems arbitrary for a business where, in some cases at least, that is not the primary motivation. Perhaps ‘universe of companies covered’ might be more appropriate (eg if they are rating the FTSE100 - and it is therefore a viable option for investment managers looking for coverage - then they should be captured). An alternative measure could be on the basis of number of clients (eg if they are selling to more than X firms they need to be regulated), although we acknowledge this could raise issues in practice.
21. What level could the criteria for small ratings providers be set at (i.e., how could ‘small ratings provider’ be defined)?
22. Is there anything else you think HM Treasury should consider in potential legislation to regulate ESG rating providers?
No further comments.
We hope you find these comments useful. Please do not hesitate to make contact if you have any questions.
Head of Policy and Communications
Secretariat to the Investor Relations Society’s Policy Committee
(Email: firstname.lastname@example.org, Tel: + 44 (0) 20 7379 1763)
APPENDIX - Extracts from EU Proposal
1. This Regulation applies to ESG ratings issued by ESG rating providers operating in
the Union that are disclosed publicly or that are distributed to regulated financial
undertakings in the Union, undertakings that fall under the scope of Directive
2013/34/EU of the European Parliament and of the Council, or Union or Member
States public authorities.
This Regulation does not apply to any of the following:
(a) private ESG ratings which are not intended for public disclosure or for
(b) ESG ratings produced by regulated financial undertakings in the Union that are
used for internal purposes or for providing in-house financial services and
(c) the provision of raw ESG data that do not contain an element of rating or
scoring, and is not subject to any modelling or analysis resulting in the
development of an ESG rating;
(d) credit ratings issued pursuant to Regulation (EC) No 1060/2009 of the
European Parliament and of the Council30;
(e) products or services that incorporate an element of an ESG rating;
(f) second-party opinions on sustainability bonds;
(g) ESG ratings produced by Union or Member States’ public authorities;
(h) ESG ratings from an authorised ESG rating provider that are made available to
users by a third party;
(i) ESG ratings produced by central banks that fulfil all of the following
(a) they are not paid for by the rated entity;
(b) they are not disclosed to the public;
(c) they are provided in accordance with the principles, standards and
procedures which ensure the adequacy, integrity and independence of
rating activities, as provided for by this Regulation, and
(d) they do not relate to financial instruments issued by the respective central
banks’ Member States.
Separation of business and activities
1. ESG rating providers shall not provide any of the following activities:
(a) consulting activities to investors or undertakings;
(b) the issuance and sale of credit ratings;
(c) the development of benchmarks;
(d) investment activities;
(e) audit activities;
(f) banking, insurance, or reinsurance activities.
2. ESG rating providers shall ensure that the provision of other services than those
referred to in paragraph 1 does not create risks of conflicts of interest within its ESG
1. ESMA shall charge fees to the ESG rating providers in accordance with the
delegated act adopted pursuant to paragraph 2. Those fees shall fully cover ESMA’s
necessary expenditure relating to the supervision of ESG rating providers and the
reimbursement of any costs that the competent authorities may incur carrying out
work pursuant to this Regulation, and in particular as a result of any delegation of
tasks in accordance with Article 41.
2. The amount of an individual fee shall be proportionate to the annual net turnover of
the ESG ratings provider concerned.
By XX XXXX XXXX, the Commission shall adopt delegated acts in accordance with
Article 45 to supplement this Regulation by specifying the type of fees, the matters for which
fees are due, the amount of the fees, the manner in which they are to be paid and, where
applicable, the way in which ESMA is to reimburse competent authorities in respect of any
costs that they may have incurred carrying out work pursuant to this Regulation, in particular
as a result of any delegation of tasks as referred to in Article 41.
1. ESG rating providers which provided their services at the date of entry into force of
this Regulation shall notify ESMA within 3 months if they want to continue offering
their services and apply for authorisation in accordance with Article 5. In that case,
they shall apply for authorisation within 6 months after the date of application of this
2. By way of derogation of the first paragraph, ESG rating providers categorized as
small and medium-sized undertaking under Article 3 of the Directive 2013/34/EU
shall apply for authorisation within 24 months after the date of application of this
3. ESG rating providers categorized as small and medium-sized undertaking under
Article 3 of Directive 2013/34/EU entering the market after [please insert the date of
entry into application] shall notify ESMA prior to starting offering their services and
shall apply for authorisation within 12 months of that notification.
Published 30 June, 2023