The FCA emphasised the increasing prevalence of providers and the potential harm from lack of regulation in this area.

By Paul A. DaviesNicola Higgs, Michael D. Green, and James Bee, and Anne Mainwaring

In June 2022, the UK’s Financial Conduct Authority (FCA) issued a Feedback Statement in response to a consultation paper on ESG integration in capital markets that it had initially issued in June 2021. The consultation sought views from stakeholders on certain issues in relation to both ESG-related debt instruments (e.g., green and social bonds) and the role of ESG data and ratings providers, topics the FCA identified as “active areas of industry debate”.

The Feedback Statement provided a summary of the responses that had been received in the 2021 consultation and set out the FCA’s proposed next steps in relation to these issues. Most notable was the FCA’s suggested approach to ESG data and ratings providers, an industry that is increasingly in demand in response to investor appetite for accessible and comparable ESG data on companies in recent years.

Rationale for Regulation

The Feedback Statement noted that the FCA sees a clear rationale for regulatory oversight of certain ESG data and ratings providers and for a globally consistent regulatory approach informed by the recommendations that the International Organization of Securities Commissions (IOSCO) developed in 2021 (for more information on the IOSCO proposal, please see this Latham blog post).

This clear rationale was stated to arise out of the increasing prevalence of ESG data and ratings providers in the global market and the potential harms of such organisations continuing to operate in an unregulated manner. The Feedback Statement noted that 39 of the 44 respondents to the consultation supported either a voluntary best practice code for ESG data and ratings providers or formal regulation of the industry. The majority of those 39 respondents favoured formal regulation.

Next Steps

Having determined that ESG data and ratings providers should be subject to regulation, the FCA noted in the Feedback Statement that it shall continue to work with the Treasury, which is considering bringing ESG data and ratings providers within the FCA’s regulatory perimeter.

Should the FCA’s regulatory perimeter be extended to cover ESG data and ratings providers, then the FCA indicated that it will “take the necessary steps” to develop and consult on a proportionate and effective regulatory regime, focusing on those areas described in the IOSCO’s recommendations. Those areas include transparency, good governance, management of conflicts of interest, and systems and controls. As the Feedback Statement notes, such regulatory regime would likely take a number of years to implement and while the market for ESG data and ratings providers continues to grow, the FCA in the interim proposes to work with the Treasury to convene, support, and encourage industry participants in creating a voluntary code of conduct addressing matters similar to those in the IOSCO recommendations. Such a code could also potentially continue to apply in relation to any ESG data and ratings providers that fell outside the scope of any future regulatory regime.

A number of other jurisdictions are also contemplating closer oversight of ESG data and rating providers.  In the EU, the Commission is exploring the use of non-binding guidelines as well as new legislation applicable to the operations of ESG rating providers to set rules regarding the authorization of ESG rating providers, their operations and transparency of their methodologies as well as rules on conflicts of interests (see this Latham blog post for further information).  The FCA emphasises that due to the global reach of these providers it is important to ensure globally consistent regulation in this market, highlighting the importance of the IOSCO recommendations in this regard.

Latham & Watkins will continue to monitor the ESG data and ratings agency market, and associated regulations in the UK and globally.