UK’s Financial Conduct Authority (FCA) to Develop a Code of Conduct for ESG Data and Ratings Providers


On November 22, the UK’s Financial Conduct Authority (FCA) announced the formation of a group to develop a Code of Conduct for Environmental Social and Governance (ESG) data and ratings providers, as mooted in the feedback to its discussion chapter on ESG integration in UK capital markets.

The FCA is awaiting a response from the UK Treasury on whether its regulatory perimeters will be extended to enable the UK watchdog to develop a regulatory regime focussed on areas highlighted in the International Organization of Securities Commissions' (IOSCO) recommendations. These include transparency, good governance, management of conflicts of interest, and systems and controls.

"While the government considers this, and to maintain momentum, we have worked to convene, support and encourage industry participants to develop and follow a voluntary code of conduct," the FCA said.

The International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG) are the secretariat heading up the group. The FCA cite that this will ensure "an unbiased and balanced representation of all key stakeholder groups. The Code will seek to be internationally consistent, by taking into account not only IOSCO’s recommendations but also developments in jurisdictions such as Japan and the EU. This will help encourage the development of consistent global standards.”

The independent group developing the code will be co-chaired by M&G, Moody's, London Stock Exchange Group (LSEG), and Slaughter and May. It will also include the FCA, the Bank of England, and stakeholders such as investors and ESG data and ratings providers. The group will aim to meet for the first time later this year.

As financial services firms continue to integrate ESG into their activities and expand their ESG-focussed products, they are increasingly users on third party ESG data and ratings services.

Given the well documented divergence in ESG ratings, it will be fascinating to see how many of the established and new ESG data and ratings providers join the group. No doubt there will be some “interesting” discussions around the key objectives cited by the FCA for the new code of conduct: transparency, good governance, management of conflicts of interest, and systems and controls.

The potential downstream effects of changes to company ESG scores were probably best highlighted earlier this year when S&P Dow Jones Indices removed electric-vehicle giant Tesla (TSLA) from its sustainability benchmark as part of the index’s fourth annual rebalance after the Elon Musk-led company’s ESG rank slipped against its global peers. S&P cited that “Tesla was ineligible for index inclusion due to its low S&P DJI ESG Score, which fell in the bottom 25% of its global GICS® industry group peers.” Elon Musk famously responded to the news via Twitter with the statement “Exxon is rated top ten best in world for environment, social & governance (ESG) by S&P 500, while Tesla didn’t make the list!” He went on to say “ESG is a scam. It has been weaponized by phony social justice warriors.”

Earlier this year in the US the Securities and Exchange Commission (SEC) announced it is assessing whether to tighten rules on index providers given their growing influence on global asset management. The regulator said it will investigate whether companies such as MSCI, S&P Dow Jones Indices (SPDJI) and FTSE Russell should be reclassified from information providers to investment advisers which could have profound implications for the way they are regulated. It suggests that index providers could be treated the same way as fund managers under the Investment Advisers Act 1940. Gary Gensler, chair of the SEC, said: “The role of these information providers today raises important questions under the securities laws as to when they are providing investment advice rather than merely information.”

As ESG indices are constructed using ESG data (for inclusions, exclusions and weightings), ESG data and ratings providers will fall within this initiative. Given that most widely adopted ESG data and ratings providers are owned by (or are part of) businesses that are also index providers, users will be watching how this all unfolds very carefully. Licensing indices or data requires very different contractual relationships to those with regulated investment advisors or sub-advisors.

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