The UK will move to regulate ESG ratings, the reform announced a year after it was revealed that companies feared being “penalised” by ESG assessments that did not “fairly reflect” their true performance.

News of fresh regulation came from chancellor Rachel Reeves, while she was in the US and Canada drumming up support for investment in the UK. She also announced a pension fund investment review aimed at encouraging fund managers to invest more in the UK, particularly in infrastructure.

During her visit, Reeves nodded to investors attending an upcoming investors’ summit she will host in October: “They recognise we have taken some difficult decisions to fix the foundations of our economy and set us on a path to sustained economic growth as government’s number one mission—it is only by doing so that we can capitalise on Britain’s immense investment potential.”

It is reported that the Financial Conduct Authority will develop the regulation. Last year, however, it was the Financial Reporting Council that produced research revealing concerns with ESG ratings agencies and their methodologies.

The report found corporate leaders were “concerned” that investors placed reliance on “headline ratings” from up to 30 global ESG ratings agencies, and the “potential existed for companies to be penalised on the basis of a rating that, in their opinion, did not fairly reflect the company’s actions or performance”.

‘Play the game’

Companies, the report said, therefore “play the game” of complying with requests for information “in the hope that they would receive a positive rating”.

The research, conducted by the University of Durham with the governance consultancy Morrow Sodali, also found that there are many ESG ratings with differing approaches. “This means there are considerable differences in terms of the reliability of the research and the approach taken to collecting and interpreting data, as well as the particular data points that are used.” This, in turn, has had a “significant impact” on the volumes of data collected and published by companies.

Investors told researchers they use the ratings “as a source of data” rather than relying on them as a primary decision-making tool.

Despite that, research has previously found that a significant number of investors believe annual reports contain “greenwashing”—exaggerated environmental claims.

In search of transparency

Companies and investors said they wanted more transparency on the methodologies used by the ratings agencies.

The Financial Times reports that UK legislation will mirror regulation elsewhere in the world, including the European Union.

Not yet implemented, the EU’s regulation has focused on ensuring ESG ratings providers are independent of the companies they rate and on rules to manage conflicts of interest.

Providers will also need to seek authorisation to operate and make disclosures on their methodologies. There are also standards for data quality.

There have been concerns elsewhere. In the US, where ESG has become part of a highly polarised political debate, regulators have previously expressed concern about ESG ratings. Regulators at the Securities and Exchange Commission recently suspended the introduction of new climate risk reporting rules after they were contested in a court action.

While driven by worthy aims, the world of ESG has been beset by controversy and scepticism. The UK government hopes to bolster the investment landscape with regulation that will strengthen the credibility of ESG claims with regulation that will match neighbouring markets.