The UK’s Investment Association (IA) has come out to “strongly oppose” including asset managers’ proprietary ESG ratings, used when marketing a fund, in planned government rules for ESG ratings providers.
The investment sector lobby body makes an exception where the individual rating is used publicly and systemically for a charge.
ESG ratings should also not be included in the scope of the proposed rules where they are used by other entities within the same group, according to the IA.
The IA made the declaration in its response to the Treasury consultation, Future regulatory regime for ESG ratings providers, the majority of points in which it largely supported.
Explaining its position, the IA stated it agrees with the consultation when it makes clear that where ESG ratings are created by an entity, such as an asset manager, solely for use by that entity, they should be excluded from the scope of the proposed rules.
However, the consultation then goes on to state that where a firm, such as an asset manager, creates ratings for their own internal use, as well as for external use (i.e. the firm sells on these ratings), that should be caught in the scope of the regulation.
The IA response to this stated: “Essentially, only where an entity is disclosing individual proprietary entity ratings publicly and systematically on a commercial basis, for a charge, should they be in scope of the regulation, not where a rating is used as part of the fund marketing.”
Also in its response, the IA pointed out investment firms are already regulated entities, and investment products are also subject to extensive regulation, giving the example of disclosure requirements around methodologies, including value assessment requirements and incoming Consumer Duty requirements.
In the IA’s view “the ultimate distinction is that ratings or data are not the product in itself, but a means to achieving a desired investment outcome”.
In this sense, “they are similar to proprietary credit ratings or internal stock ratings that firms utilise for portfolio construction purposes, and they do not need to be regulated,” it stated.
ESG ratings ‘increasingly influential’
The IA wants proprietary ESG ratings used for product purposes to be treated in the same way as those ratings used in mainstream investment products, “irrespective of whether they are disclosed to clients, at product level or not disclosed at all”.
Carol Thomas, head of sustainability and responsible investments at the IA, said: “We support bringing both ESG ratings and data providers under the regulatory perimeter to ensure that all aspects of the market for sustainable and responsible investment products are rooted in clarity and transparency that delivers for end clients.
“It is important, however, that new regulation provides the flexibility for the market to continue to innovate and meet the demands of our industry, as sustainable and responsible investment continues to grow and evolve”.
ESG ratings are assessments which increasingly influential and drive investment decisions in financial markets.
As part of the Edinburgh reforms in December 2022, the chancellor announced the government wants to ensure improved transparency and good conduct in the ESG ratings market.
Research cited in the government consultation shows a change in an ESG rating of an entity can lead to responses in financial markets, and in 2020, 65% of institutional investors were found to use ESG ratings at least once a week.
This influence becomes more material when firms embed ESG ratings into their investment processes (e.g., in benchmarks and indices, or in investment mandates). It is amplified further when it comes to the largest ESG ratings providers.
Despite their increasing prominence, market participants have raised concerns about ESG ratings, the government consultation stated, with some challenges raised in relation to ESG ratings providers’ methodologies and objectives, “which can be opaque and lead to confusion about what a rating implies”.
HM Treasury launched a consultation on a potential regulatory regime for ESG rating providers, which closes on 30 June 2023, and responses will inform the government’s next steps.