The UK government has launched a consultation on the purpose and scope of planned regulation for ESG ratings providers amid a swathe of other measures, consultations and commitments in its updated Green Finance Strategy.

The strategy updates a previous document published in 2019, which set out the government’s regulatory and policy agenda for green finance.

Among the announcements is a long-awaited consultation on the scope and rationale for regulation of ESG ratings providers. The consultation will see assessments of any kind of environmental, social or governance factor within financial markets brought under the regulatory purview, and will cover ratings provided by both UK and overseas firms to UK-based users.

However, the government also proposed a long list of exceptions. The proposed regulatory expansion would not cover raw data that does not have an assessment element, ratings provided by non-profits, credit ratings, second-party opinions, proxy advice and academic research and journalism.

A separate chapter of the consultation also covers proportionality for smaller providers, including the possibility of an opt-in mechanism or reduced requirements.

The Financial Conduct Authority, which has previously said it sees a “strong rationale” for ratings to be brought within its regulatory sphere, welcomed the announcement. Sacha Sadan, the regulator’s director of ESG, said the move would improve confidence in the market and support the transition.

“We welcome today’s announcement and will continue to work with the government on the next steps – with a focus on transparency, good governance, managing conflicts of interest, and robust systems and controls,” he said.

Lorraine Johnston, financial regulation partner at law firm Ashurst, said she expected “significant pushback” against the proposals, noting that the broad range of firms in the proposed scope was “arguably more onerous than the more limited scope for benchmark administrators or credit rating agencies”.

Green Finance Strategy – top takeaways

  • Consultation launched on scope of regulation for ESG ratings providers.
  • Clarification of fiduciary duty for pension fund trustees in relation to the net-zero transition.
  • Commitment to consult on UK taxonomy by autumn 2023. Nuclear will be included.
  • Government will review ISSB standards as soon as they are finalised, with the support of two new working groups.
  • New framework for nature markets, outlining commitment to “accelerate the development of high-integrity markets that enable firms to finance the provision of ecosystem services”.
  • Consultation on mandatory disclosure of transition plans for large corporates in autumn or winter.
  • Call for evidence on Scope 3 reporting to understand “costs and benefits” of production and usage.
  • Plans to investigate integration of TNFD reporting into UK regulatory and policy framework once standards are finalised.

Among the other measures set out in the strategy was a commitment to consult on the UK’s delayed green taxonomy in autumn 2023. The government had been expected to legislate on the taxonomy by the end of last year, but said in December that it would miss the deadline.

The government reiterated its support for including nuclear in the taxonomy, a proposal which has received lukewarm support from the market. There was no suggestion that natural gas would be considered for inclusion.

Companies will be expected to report voluntarily against the finalised taxonomy for the first two years, the government said, after which it will look at mandating disclosures.

In other disclosure measures, the government will call for evidence on Scope 3 emissions reporting for corporates and will launch a consultation on introducing mandatory transition plan disclosures for large companies once the Transition Plan Taskforce (TPT) has finalised its framework.

It will also assess the first two ISSB standards for adoption in the UK once they are finalised, expected to be this summer.

To assist in assessing the ISSB standards, the government plans to establish two advisory committees, one government-led and the other independently chaired, to look at public policy and technical standards, respectively. The aim is to make an endorsement decision within 12 months of final standards being published, but a decision will be made sooner “if possible”.

Stewardship standards

Turning to stewardship, the government confirmed plans for the Financial Reporting Council to review the regulatory framework for stewardship activities, including the UK Stewardship Code.

It will also look to clarify fiduciary duty for pension fund trustees. While guidance published last year by the Department for Work and Pensions (DWP) suggested that stewardship could include both financial and non-financial matters, the government said there was still confusion.

The strategy acknowledges that “decisions around investing and systemic risks are complicated”, and that trustees would like further clarification of their fiduciary duties in the context of the net-zero transition.

With this in mind, the DWP plans to examine how far its guidance is being followed, and UK legal non-profit Financial Markets and Law Committee will set up a working group to consider the issues. The government also plans to hold a series of roundtables later this year to examine how it can continue to clarify fiduciary duties.

Nature focus and carbon credits

The government has also today published its Nature Markets Framework, in which it commits to accelerate the development of high-integrity markets that enable firms to finance the provision of ecosystem services.

In a foreword, Thérèse Coffey, secretary of state for environment, food and rural affairs, said: “We need to scale up the flow of private finance to nature, so that farm businesses and the growing pipeline of nature projects have access to the investment they need to grasp the opportunities of the transition to a nature-positive economy.”

The framework lays out core principles to ensure markets operate with integrity and deliver positive outcomes. These include guaranteeing that credits or units issued are based on new environmental improvements and verified against an appropriate baseline, as well as the need to avoid double counting.

In the development of the principles, the government drew on international best practices emerging from initiatives such as the Integrity Council for Voluntary Carbon Markets (IC-VCM).

Politicians and regulators will consider the outcomes of the IC-VCM and the Voluntary Carbon Markets Integrity Initiative (VCMI) and “consult on next steps, seeking views on the role of specific government and regulatory interventions to enable the growth of high-integrity voluntary markets, maximising synergies between carbon and nature markets where appropriate”.

Alongside the principles, the document said the British Standards Institution has been appointed to expedite a pipeline of investment standards for nature markets, starting in early 2023 and continuing for up to three years.

“These UK-wide standards will drive the application of consistent principles and approaches to the quantification of ecosystem services. They will provide a benchmark by which successful methodologies can be recognised as sufficiently robust and credible.”

The strategy included wider commitments on nature, with policymakers pledging to work with financial institutions to further tackle deforestation-linked finance.

It added that when the final TNFD framework is published, expected to be in September, the government will explore how it should be “incorporated into policy and legislative architecture”. Making TNFD reporting mandatory would fulfil Target 15 of the Global Biodiversity Framework agreed at COP15 last year.

Mixed reaction

The UK’s main financial regulators – the FCA, Financial Reporting Council, The Pensions Regulator and the Bank of England – put out a joint statement welcoming the strategy.

The three CEOs and the BoE governor said they stood ready to support the government in implementing its policy objectives.

Not everyone was as enthusiastic. Lewis Johnston, director of policy at ShareAction, said the strategy was “little more than a restatement of existing commitments”.

While welcoming the review of fiduciary duties for pension scheme trustees, Johnston was critical of the proposed rules on corporate transition plan disclosure, noting that they do not include a requirement to develop such a plan.

He also said it was “disappointing” that a specific date had not been set for the consultation on the UK taxonomy given repeated delays to the process.

These criticisms were echoed by Brendan Curran, policy fellow at the LSE’s Grantham Research Institute. He said the strategy “has failed to deliver a clear roadmap that will deliver the annual investment needed for net zero, lacks any additional money to support the transition and leaves us trailing behind the rest of the globe”.

“It is a mixed bag overall and the UK government must take further action to ensure financial stability as climate change continues, provide financial regulators with a net zero statutory objective, and ensure the Bank of England’s Climate Hub is sufficiently well-resourced.”

James Alexander, CEO of UKSIF, welcomed the “much-needed” clarity provided by the update, in particular the clarifications to fiduciary duty and actions on transition plans and the green taxonomy.

“We hope to see further crucial policy detail outlined as soon as possible in the upcoming consultations,” he said.