Amanda Cooke: A clear transition timetable and proportionate expectations would help firms plan, budget and implement changes without disrupting service.
The latest of the Society of Pension Professionals’ (SPP’s) regular columns looks at the Financial Conduct Authority’s (FCA’s) regulatory push on ESG ratings.
The UK government sees sustainable finance as a growth sector and is increasing scrutiny of ESG ratings.
For pension schemes, ESG ratings can influence manager selection, stewardship priorities, and reporting. They might also be used as shortcuts when comparing funds or issuers.
Inconsistent methodologies and limited visibility on inputs can therefore affect investment decisions and the way trustees explain outcomes to members and regulators.
In its recent consultation the Financial Conduct Authority (FCA) proposed the UK's first stand‑alone regime for ESG rating providers.
The regime would apply to firms that produce ESG ratings i.e. assessing one or more ESG factors using a stated methodology and ranking system.
It excludes some activities – such as academic work and ratings produced as part of existing regulated services. The FCA wants ratings to be more transparent, reliable and understandable, through rules on disclosures, governance, systems and controls, conflicts of interest and stakeholder engagement.
Responses, including the SPP's submission, broadly supported the objectives but identified practical issues, including disproportionate impact on smaller providers and ongoing challenges around data quality and access.
Transparency and disclosure
Transparency is central to the regime, requiring publication of minimum disclosures on methodologies, data sources, assumptions, conflicts of interest and complaints handling, at product and individual rating level. The disclosures should be clear, accurate and kept up to date.
The rules could be clearer on timing, with the SPP suggesting at least annual updates, and we also suggested including conflict risks and mitigations within the main disclosures, rather than a separate document, so users can find key information in one place thus reducing governance requirements for providers.
Providers could also be required to disclose the KPIs used for each E, S and G factor, as KPI choices are a major driver of ratings divergence. It may also help to include more general information on how charges are set.
There are concerns about fragmented and inconsistent data across jurisdictions. Where issuer data is incomplete or unreliable, providers (especially smaller firms with limited access to global datasets) may struggle to meet disclosure requirements.
Providers must notify users and rated entities in writing before any material change to a methodology and allow time to assess the impact before it takes effect. Public disclosures must be updated as soon as reasonably practicable after any material change to the ESG rating product-line. Clear guidance on what counts as material would reduce uncertainty and potential costs and disputes.
Governance
Authorised providers will be accountable for the end‑to‑end ratings process and must have sufficient UK presence for FCA supervision. For international firms serving the UK without a local base, establishing this presence could be a major cost. Groups with complex structures may need to adjust their operating models.
The FCA also proposes applying the senior managers regime. Given the sector's mixed backgrounds, common ESG competence standards or qualifications could improve consistency but will need time and investment to ensure compliance.
Greater transparency may increase litigation risk, so firms will need strong controls and legal review.
Impact on smaller providers
Meeting the new requirements is likely to require significant investment, with the FCA recognising that implementation may be "technically demanding, requiring extensive IT development and system integration".
Providers will also need to balance transparency with protecting intellectual property and commercial advantage. Those costs may fall disproportionately on smaller providers and could affect competition and market entry, reducing consumer choice.
The road ahead
The framework is broadly welcome and should make ESG ratings clearer and easier to use. However, it must be proportionate, so it does not stifle innovation or competition.
A clear transition timetable and proportionate expectations would help firms plan, budget and implement changes without disrupting service.
Amanda Cooke is chair of the SPP's financial services regulation committee and of counsel at CMS
