ESG ratings – DRWG voluntary Code of Conduct consultation

The Financial Inclusion Centre has submitted a response to the consultation issued by the Environmental, Social and Governance (ESG) Data and Ratings Working Group (DRWG) on the voluntary Code of Conduct for ESG Ratings and Data Product Providers.

The DRWG was set up by the Financial Conduct Authority (FCA) to create the voluntary Code of Conduct. Our response can be found here: Financial Inclusion Centre submission DRWG Code of Conduct for ESG Ratings and Data Product Providers 1023

As we explain elsewhere, financial markets continue to finance climate damaging economic activities at scale and there is a serious risk of greenwashing in financial markets. Financial markets, climate change, economic and social utility Moreover, we have raised concerns about ‘social impact’ washing. Preventing social impact washing

ESG ratings and data product providers, if properly regulated and as part of a wider set of regulatory reforms, could play an important role in realigning financial markets with environmental and other social goals. The Devil is the policy detail – will financial regulation support a move to a net zero financial system? | The Financial Inclusion Centre

The FCA has said it wants ESG ratings to be regulated but it will have to wait until HM Treasury gives it the powers to do so. Until then (if statutory regulation ever happens), the FCA has set up the DRWG to develop the voluntary Code of Conduct.

Unfortunately, the FCA’s approach to establishing this particular interim voluntary Code of Conduct means that it is unlikely to significantly improve the behaviours of ESG ratings providers and financial institutions. The FCA has set very limited objectives and outcomes for the Code of Conduct.

We argue that if this interim Code is to make a positive contribution to the efforts to discipline market behaviours, then it should produce the following outcomes:

  • ESG data and ratings are trustworthy, meaningful and relevant, easy to understand, and of a consistently high standard
  • ESG data and ratings are produced and published by providers that operate to the highest standards of integrity and are not subject to conflicts of interest
  • Investors and other end-users are able to make effective, informed decisions relating to ESG factors
  • Positive climate behaviours and practices are promoted and climate damaging activities are deterred and punished – this should apply to financial institutions and the underlying economic entities those institutions invest in, finance/ lend to, and insure
  • Financial institutions and intermediaries, and underlying economic entities use ESG data and ratings responsibly

But, it is concerning that the FCA and the DRWG appear to have said little or nothing about oversight and monitoring, or transparency and reporting on compliance with the Code. Nor has the FCA or the DRWG said anything about sanctions for non-compliance or how signatories and other market participants use the Code responsibly.

Moreover, the governance of the DRWG itself is a particular cause for concern. The DRWG has no civil society representation to speak of. The Steering Committee, DRWG, and secretariat is dominated by industry representatives.  4/4 Co-Chairs, 18/20 of the Working Group Members, and 4/4 of the Secretariat of the DRWG  are industry representatives.

Accountability mechanisms are also weak. The FCA intends that meetings will be conducted under the Chatham House rule. Comments, dialogue and feedback within the DRWG’s meetings will not be attributable to individuals or the organisations they represent or with which they are associated. The Chatham House rule will also apply in any situation where a formal conversation occurs relating to the work of the DRWG.

The DRWG in its consultation has said that consultation submissions will not be made public and says only that a feedback statement may be shared to capture key issues raised by stakeholders. Although it does not specify who this feedback might be shared with.

This is a remarkable state of affairs at a time when regulatory governance and accountability is meant to be paramount.

The FCA says that the DRWG should seek to publish a draft of the voluntary Code of Conduct for consultation approximately within six months of the group’s first meeting, with the final version of the Code within approximately four months of the start of the consultation. The FCA also says the DRWG should set out its recommendation on the ownership of the Code – the body responsible for hosting and maintaining the Code, as appropriate – when the final version of the Code is published – at the latest.

We are very concerned about the ability of a DRWG, so heavily dominated by industry representatives, to deliver a meaningful Code of Conduct.  In our view, the FCA must be more than observers on this group. It must take the lead to ensure this DRWG acts in the public interest to counter the influence of the industry dominance on the DRWG.

Moreover, the FCA cannot allow this DRWG, as constituted, to determine ownership of the Code. At the very least, the regulator must approve the recommendation of Code ownership.