The UK | an early leader in ESG ratings codes of conduct

A voluntary code of conduct is a stepping stone in developing regulatory standards for ESG ratings. Furthermore, voluntary commitments have a role in raising standards now – without the need to wait for regulation to catch up with practice. The UK is helping to lead the way globally with the launch of a new code which will see providers enhancing their credibility and transparency. 

When Rishi Sunak was Chancellor he set the challenge for the UK to be the world’s first net zero aligned financial centre. Raising standards on ESG data and ratings is an important part of this ambition as it will help investors in the UK assess the sustainability of the firms they may invest in.

Calls for greater clarity in ESG data and ratings

As a result of the growing need for transparency in ESG products, ESG ratings and data products providers have come under greater scrutiny. Shareholders, investors, rated entities, and users are increasingly concerned with clear, high-quality, and reliable ESG ratings and data products. And there are widespread calls for closer regulatory oversight in the ESG market.

The International Organization of Security Commissions’ (IOSCO) put out a call to action to address a lack of oversight. It has also encouraged the development of best practice policy in the form of legislative initiatives or the creation of codes of conduct.

A code of conduct for ESG whilst regulation is considered

Until regulation is established, a Code of Conduct can help improve trust in ESG products, especially those relevant to the financial services sector. It can guide investors in allocating their money to the right assets as well as alleviate the risk of greenwashing. 

HM Treasury is currently consulting on bringing ratings providers into the regulatory perimeter. But in the meantime, the FCA has tasked International Capital Market Association (ICMA) and the IRSG, which is co-sponsored by the City of London Corporation and TheCityUK, to develop an industry-led voluntary code of conduct for ESG ratings providers. The Code of Conduct is an interim solution before potential regulation comes in to play, and it and will inform any future regulation.

The code will be internationally consistent, taking into account IOSCO’s recommendations. It seeks to create a comprehensive, coherent ESG ratings system that will enable investors to embed sustainable decisions more confidently into their businesses. The work currently underway in the UK could have global implications as regulators worldwide stand to use its framework to develop globally consistent and proportionate regulation.

Today is an important step in increasing transparency and trust in the growing market for ESG data and ratings products. It’s also vital that the Code has been developed with international consistency in mind. We thank the Secretariat for their hard work and encourage everyone to take part in the consultation.

Sacha Sadan, FCA Director of ESG

The UK: an early leader in ESG ratings codes of conduct

On Wednesday July 5th the ESG Data and Ratings Working Group (DRWG), convened by the IRSG and ICMA,  released a draft Code of Conduct for consultation. This makes the UK one of the first countries in the world to develop a code of conduct for ESG ratings and data, after Japan. The ambition is that the new code will become a global resource, serving as a template to use in other jurisdictions.

Overview of the Code of Conduct

The Code of Conduct aims to foster a trusted, efficient, and transparent market, by introducing clear standards for ESG ratings and data products providers.

Informed by IOSCO, the Code of Conduct sets out six best practice principles to address several key problems that exist in the system today: transparency, governance, systems and controls, and management of conflicts of interest.

Good Governance

Principle 1 calls for ESG ratings and data products providers to ensure appropriate governance arrangements are in place. This includes appropriate management of conflicts of interest, transparent procedures, as well as support competent personnel and sufficient resources.

Systems and Controls

Three principles, principles 2, 5, and 6, call for ESG ratings and data products providers to have sound systems and controls by adopting and implementing written policies and procedures.

This will ensure a high quality of products, consistency and effective engagement practices helping users to make informed decisions.

Conflicts of Interest

Principle 3 calls for ESG ratings and data products providers to manage activities that may compromise the independence and objectivity of ESG ratings and data products providers’ operations.

Establishing appropriate policies and procedures to address conflict of interests, mitigates the risk of undermining the independence, integrity, reliability, and credibility that informs the issuance of an ESG rating or data product.

Transparency

Principle 4 calls for adequate levels of public disclosure and transparency as a priority for ESG ratings and data products. Specifically, this includes greater transparency of methodologies and processes to support an increased understanding for users. At the same time appropriate levels of disclosure should maintains a balance with respect to proprietary or confidential information.

How the ESG Code of conduct was developed

In November 2022, ICMA and the IRSG convened the DRWG – an industry-led working group,. The DRWG brought together international stakeholders from the UK, the EU and the US representing ESG ratings and data products providers, rated entities, academics, and users such as asset managers, asset owners and banks.

The FCA, the Bank of England and other relevant financial regulators and government departments sit as active observers on this group.

The Code was developed by the four co-chairs from Moody’s, M&G, LSEG, and Slaughter and May, and the Secretariat and DRWG members.

Members of the DRWG have worked hard to make sure the Code of Conduct is internationally consistent, primarily through close alignment with the International Organization of Securities Commissions’ recommendations but also through taking into account developments in jurisdictions such as Japan, Singapore and the EU. We hope the Code of Conduct will be a significant step in the development of consistent global standards for ESG Data and Ratings providers.

Steering Committee (the four co-chairs)

Have your say on ESG ratings draft code of conduct

The Draft Code of Conduct is now out for consultation. It is essential that  ESG ratings and data providers, users and rated entities and other interested stakeholders provide their feedback so we can build a framework that considers their needs. This will close on the 5th of October.

Submissions can be made to drwgsecretariat@icmagroup.org.

The IRSG and ICMA are due to publish the final Code at the end of 2023. Ultimately, the government might deem it necessary to implement a formal regulatory regime. But there is no need to wait for that. The Code of Conduct has a vital role to play in raising standards now.