The Financial Conduct Authority (FCA), the UK’s financial regulator, recently announced its plans to regulate ESG ratings, with the aim to make them more reliable, transparent and comparable.
Its decision to make the changes followed an industry consultation, in which, 95% of respondents were in favour of the FCA bringing ESG ratings into its remit. The goal is to build clear and proportionate rules for transparency and governance to build greater trust in the ratings. It claims the changes could result in around £500m in net benefits over the next decade.
Under the proposed changes, there would be a focus on increased transparency to facilitate easier comparisons to support those using the ratings and those rated. It would also facilitate improved governance, systems and controls to ensure clear decision-making and strong oversight and quality assurance. Other areas of focus would be on identification and management of conflicts of interest and setting clear expectations for stakeholder engagement and complaints handling. All of these would be in addition to other existing FCA rules being applied to the ratings.
Speaking on the proposals, Sacha Sadan, director of sustainable finance at the FCA, emphasised the importance of improving ESG ratings and how it could provide significant benefits to the UK. Sadan said, “This will enhance the UK’s reputation as a global sustainable finance hub – attracting investment and supporting growth and innovation.”
In the wider market, there is a notable appetite for these changes. With nearly all of the consultation’s respondents voting in favour of changes, it is clear this could be an important change to the UK’s ESG regulatory landscape.
Fredrik Davéus, CEO and co-founder of Kidbrooke, explained that ESG ratings carry “enormous weight”, as they influence product construction, client recommendations and regulatory disclosures. Despite this, they lack the same level of scrutiny as the methodologies producing them.
He said, “That asymmetry was always going to become a problem. When a credit rating agency produces a rating, there are well-understood frameworks governing how that rating is derived and what it means. ESG ratings have had no equivalent. Two providers can look at the same company and produce materially different scores, using different data, different weightings, and different definitions of what ESG actually means.” As such, Davéus believes these proposals are long overdue.
These proposals have caught the attention of the UK’s Investment Association (IA), a trade body representing the investment management sector with over 200 members. Following the close of the consultation, it released an official response highlighting its support for the framework. In its response, the IA urges the FCA to clarify borderline cases, ensure consistent interpretations across providers and to leverage lessons from the EU’s ESG Ratings Regulation.
How the regulations can improve benefits
During the FCA’s initial consultation, it found respondents did not have enough faith in current ESG ratings. It highlighted that 55% of respondents were worried about how they were built and 48% were concerned about how transparent they were.
Davéus believes this trust issue is built on two layers. The first is methodological, as rating providers use different frameworks, which can look vastly dissimilar due to there being academic disagreement about how ESG factors should be measured and weighted. “That creates divergence that is confusing but not necessarily dishonest.” Davéus said.
The second layer, which Davéus argues is more troubling, is the opacity of how ratings are produced. This lack of visibility means firms are using ratings but do not know whether the rating accurately reflects the underlying ESG characteristics or the quality of a company’s ESG reporting. He said, “Companies with sophisticated investor relations teams and large sustainability disclosure budgets can score well regardless of their actual environmental or social impact. That conflation of disclosure quality with ESG quality is where a lot of the mistrust originates which is entirely rational.”
Improving transparency and governance are some of the core areas the FCA will explore as part of its changes. As such, it could help to reduce the lack of trust firms have. Davéus noted that bringing ESG rating providers into a regulated framework, requiring transparency around methodologies, management of conflicts of interest and minimum standards for how ratings are delivered, could improve the ecosystem. However, while this can improve the ecosystem, it will not lead to a future where all providers give the same rating, but this is something Davéus believes is good for the market.
He said, “It will meaningfully raise the floor. It won’t eliminate divergence between providers, and I don’t think it should: different methodological approaches reflect genuine differences in what investors prioritise, and that pluralism has value. But it will make the divergence legible.
“Firms will be better equipped to understand why two ratings differ and make an informed choice about which methodology aligns with their investment philosophy and their clients’ preferences. The broader market impact will be a gradual consolidation of trust, which is ultimately what the ESG investment case needs to fulfil its potential.
“Right now, a meaningful segment of wealth management clients is sceptical of ESG products precisely because they’ve read about greenwashing and rating inconsistencies. Regulatory credibility is a precondition for rebuilding that trust at scale.”
Any recommendations
The full rules are expected to be released in the final quarter of the year and will come into effect in 2028.
On Davéus’ wish list is an improvement to the underlying data infrastructure that ratings are built on, but he is unsure the regulation alone will be enough. “Even well-intentioned, methodologically rigorous rating providers are constrained by the quality and consistency of the company-level data they ingest. Until ESG disclosures are standardised at source, which initiatives like the ISSB standards are beginning to address, even the best rating methodology is working with imperfect inputs.”
From his experience, financial institutions are struggling to consume and normalise ESG data across various providers and causing significant fragmentation challenges. He added that wealth managers are struggling to collate data across planning, advice and reporting workflows from three or four sources that do not agree.
On a final note, he said, “Regulating the ratings is necessary. But the bigger unlock for the sector will come when the data feeding those ratings and the infrastructure consuming them, is genuinely consistent end to end.”
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