Request Free Trial
December 14, 2023

Strong code of conduct for ESG raters needed to combat greenwashing

By Chris Hayward
The joint initiative from the financial services industry has put the UK among the first countries in the world to develop a code of conduct for ESG ratings and data (Photo: Chris J. Ratcliffe/Bloomberg)
The joint initiative from the financial services industry has put the UK among the first countries in the world to develop a code of conduct for ESG ratings and data (Photo: Chris J. Ratcliffe/Bloomberg)

With greenwashing an ongoing concern, a UK industry-led initiative has formulated a code of conduct for ESG ratings and data providers to ensure the integrity of and confidence in sustainable investment

Since the publication of the UN’s “Who Cares Wins” report some two decades ago – where environmental, social and governance was given its first mainstream mention – there has been backlash against the subsequent shift to sustainable investing.

A key concern is the level of transparency, quality and reliability of ESG ratings and data products. In the current push to stamp out greenwashing, such alarm bells cannot be ignored. Sustainable finance is a key pillar in the drive for net zero – it’s paramount, therefore, that the market has confidence in ESG ratings and data products.

A crucial tool to comprehensively address these concerns is the establishment of a standardised code of conduct. This ensures shareholders, investors, rated entities and users are given clear, high-quality and reliable ESG ratings and data products, and also provides regulatory oversight of the market.

Growing demand

I saw firsthand the conversations at COP28 around the shift in capital toward sustainable activities. ESG ratings are a vital component of this capital reallocation so both demand for and reliance on these products is only expected to grow.

Today, the UK publishes its first code of conduct for ESG ratings and data products providers developed by the International Capital Market Association and the International Regulatory Strategy Group – co-sponsored by the City of London Corporation and TheCityUK.

The ICMA and the IRSG formed a working group, commissioned by the Financial Conduct Authority, bringing 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.

This was a truly industry–led initiative, taking into account concerns and proposals from across the sector to develop regulatory standards for ESG ratings that are consistent and transparent. This makes the UK one of the first countries in the world, after Japan and Singapore, to develop a code of conduct for ESG ratings and data. The ambition is that the new code will become a global resource, serving as a template for use in other jurisdictions.

Although HM Treasury consulted earlier this year on bringing ratings providers into the regulatory perimeter, such regulation can take time in a sector that urgently needs guidance. This is the benefit of an industry-led, voluntary code of conduct: it’s developed by the sector, for the sector.

Informed by the International Organization of Securities Commissions, 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.

Principles of the code

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 supporting competent personnel and sufficient resources.

Three 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 the high quality of products, consistency and effective engagement practices to help users make informed decisions.

Principle 3 calls for ESG ratings and data products providers to manage activities that may compromise the independence and objectivity of their operations. Establishing appropriate policies and procedures to address conflict of interests mitigates the risk of undermining the independence, integrity, reliability and credibility that inform the issuance of an ESG rating or data product.

Finally, and possibly most importantly, 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 and increase users’ understanding. At the same time, appropriate levels of disclosure should maintain a balance with regard to proprietary or confidential information.

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 and delivering consistency now – and we urge providers to sign up.

Chris Hayward is the policy chair of the City of London Corporation

A service from the Financial Times