Upcoming ESG ratings regulation

What to expect

In response to the increasing focus on how ESG ratings are determined and used in financial markets, the new UK government has announced in August 2024 that new regulations are being introduced. This follows the conclusion of an HMT consultation in 2023 and, given a similar confirmation in the EU earlier this year, the draft EU text is likely to be the most helpful proxy for what the UK text will look like. It’s also worth noting that other jurisdictions such as Japan and Singapore are implementing their own requirements for ESG ratings providers. These regulations mandate that companies providing ESG ratings adhere to stringent standards covering transparency in methodologies, organisational requirements, conflicts of interest, and more.

Key areas of the new regulation

1. Transparency in Rating Methodologies
   Disclosure of methodologies, models, and key rating assumptions on the website in a clear and transparent manner.
2. Independence and avoidance of conflicts of interest
   Establish robust governance structures with clear roles and responsibilities, ensuring ESG ratings are free from conflicts of interest, whether from internal or external sources.
3. Disclosure
   Disclosure of comprehensive information on their methodologies, data sources, ownership, and how they address conflicts of interest and data limitations.
4. Personnel
   Ensure analysts and employees involved in ratings are well-trained. Those involved in rating cannot trade related financial instruments, must avoid conflicts of interest, and protect confidential information.
5. Record-keeping
   Maintain a record of ESG rating activities and keep them for at least five years in a manner that allows for the replication and full understanding of the ESG rating determination.
6. Complaints-handling
   Establish and publish procedures for receiving, investigating, and retaining records of complaints from users, rated items, and issuers. These procedures should ensure complaints are investigated fairly and independently, and outcomes are communicated timely.
7. Outsourcing
   Ensure that outsourcing of important operational functions does not impair internal control quality or the ability to supervise compliance. Ratings providers remain fully responsible for meeting all regulatory obligations and disclosing required information, even when outsourcing functions or services relevant to ESG ratings.

How to prepare for the new regulation

Given this is an entirely new regulated area, ESG rating providers must take a proactive approach to ensure compliance. The following steps will help:

1. Formulate a response:
   Gather relevant parties together and assign responsibilities across Compliance, Legal and the business. Establish a steering group with objectives and a timelines.
2. Review and update methodologies:
   Conduct a thorough review of your current rating methodologies and ensure they align with the new transparency requirements.
3. Strengthen governance structures and internal controls:
   Establish or enhance your governance framework, ensuring that robust internal controls and audit processes are in place.
4. Implement conflict of interest policies:
   Develop and enforce policies to manage and disclose conflicts of interest.
5. Enhance data quality assurance:
   Adopt stringent standards for data collection, validation, and verification. Regularly review and audit your data sources and adherence to your methodology to maintain high data quality.
6. Prepare for regulatory engagement:
   Stay informed about the specific requirements of the regulation as they are released. Prepare for registration, licensing, and ongoing reporting obligations. Engage with regulatory authorities and industry groups to stay updated on best practices.

How we can help

At PwC, we specialise in preparing companies for new regulations, audits and ensuring compliance. Our team is highly experienced in the intricacies of regulatory compliance for data and index providers - a similar parallel regime to ESG ratings providers - and can provide comprehensive support whilst leveraging our ESG subject matter experts with wide experience in working with the users of ESG ratings and asset managers. Our services include:

• Regulatory readiness assessments: Evaluate your current practices and identify gaps relative to the new regulatory requirements.
• Governance, risk and controls development: Assist in developing and documenting policies and frameworks to create or enhance your existing structures and processes.
• Audit: Delivery of high quality audits in line with professional assurance standards, including appropriate independence requirements. Audit reports can be made available to stakeholders to demonstrate adherence to the regulation and differentiate in the marketplace.

By partnering with PwC, you can demonstrate your commitment to regulatory excellence and position your company as a leader in the ESG rating industry. Contact us today to learn more about how we can help you navigate these upcoming regulatory changes and stay ahead of the curve.