UK Government Consults on Regulation of ESG Ratings Providers

As part of its new Green Finance Strategy, HM Treasury has published a consultation paper on proposals to regulate providers of environmental, social and governance ratings. Such ratings providers offer assessments on a firm’s exposure to ESG risks or a firm’s impact on ESG matters. HM Treasury has found that these assessments increasingly trigger responses in financial markets and should therefore be subject to regulation. Responses to the consultation should be submitted by June 30, 2023.

Under the proposals, ESG ratings providers would need to become authorized, by virtue of a new activity that is to be regulated under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 if they directly provide:
 
This will include ESG ratings used in relation to cryptoassets, if HM Treasury’s proposals to add cryptoassets to the list of specified investments go ahead (we discuss the overall proposals for cryptoasset regulation in our client note: “UK Proposals for Cryptoasset Regulation”). “Direct provision” covers ESG ratings given to paying U.K. customers, regardless of the location of the ratings provider. HM Treasury will consider whether certain indirect provision of ratings should also be regulated (e.g., where an ESG ratings provider does not have a contract with a U.K. user but its ratings are made available to that user). The consultation seeks input on how its proposals may affect benchmark providers. Although the proposals are not expressly directed at benchmark administrators, it is feasible that they could capture benchmark providers that offer ESG benchmarks and also provide ESG ratings to individual companies.

There would be certain exclusions from the regulated activity, for example the creation of a rating by an entity for its sole use (e.g., asset managers that develop ratings to inform their own investment decisions). Credit ratings that consider ESG factors would be excluded, as they are already separately regulated. External reviews of ESG-labeled bonds are also among those activities proposed to benefit from an exclusion. It is also proposed that pure ESG data (i.e., with no assessment of the data involved) would be out of scope of regulation.

To protect competition and ensure small ESG ratings providers are not disproportionately affected by the proposed regime, HM Treasury is considering varying the regulatory requirements depending on the size of the ratings provider.

HM Treasury intends the U.K.’s proposals to take account of wider international developments in ESG regulation, for example the International Organization of Securities Commissions’ recommendations, to avoid fragmentation of the market. It has left open the possibility of also regulating a subset of ESG ratings providers in other ways, for example through the new Designated Activities Regime set out in the Financial Services and Markets Bill 2022. Firms operating under the DAR would not need to be authorized, or obtain permission to conduct their activities, but would be subject to requirements imposed by HM Treasury or the FCA.
 
The consultation paper is not clear on the position of U.K.-based or third country benchmark administrators which are already regulated under the U.K.’s Benchmark Regulation (EU Regulation 2016/1011, as applicable in the U.K. under the European Union (Withdrawal) Act 2018) – merely stating that “HM Treasury and the FCA will consider how any new requirements in this area fit in with existing regulatory regimes. Views are welcome from respondents on whether there are areas where new regulation on ESG ratings could overlap with existing regulation, such as the UK Benchmarks Regulation, and what the effects of this would be.” There is notably however no current proposal to exclude those subject to the U.K. BMR from the proposed new regulated activity for ESG benchmarks.  As a result, U.K. and overseas entities that are already regulated under the BMR would fall within the regulated activity of being an ESG ratings provider – the paper says the following on territorial scope: “HM Treasury proposes to capture, at a minimum, the direct provision of ESG ratings to users in the UK, by both UK firms and overseas firms.”  As regards registered third country benchmark administrators, there is notably no current proposal to extend Article 72 of the RAO (the overseas persons exclusion) to this activity.

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