ESG ratings have become a hot topic in recent years with many investors looking to find financial products which align with their environmental and societal goals. ESG ratings provide an opinion on a company’s or financial instrument’s sustainability profile, by assessing its risk and impact on the environment and society. Due to these ratings being essential to investors’ trust in financial products, they are facing increasing regulatory challenges from both the EU and the UK. But what does the changing regulatory environment mean for the investors they are trying to help? And how can ESG consultants capitalise on the changing legal landscape?
Both the UK and the EU have released new staunch rules in an attempt to curb firms from making bogus ESG ratings that mask the true impact of certain financial instruments on society.
In November 2023, the UK finalised a new law concerning sustainability disclosure requirements and investment labels. This includes a general anti-greenwashing rule, a fund labelling regime, and a disclosure regime. The anti-greenwashing rule aims to ensure that firms’ sustainability references are fair and proportionate to the sustainability profile of the product and service, while the fund labelling and disclosure regimes place additional checks and requirements on asset managers who wish to label products that achieve positive sustainability outcomes. This is taken a step further by requiring the firms that conduct ESG ratings to be approved by the Financial Conducts Authority, subjecting them to greater supervision and regulation.
The EU has also launched a wave of regulatory challenges against ESG firms, finalising laws last week that require ESG rating agencies to be approved by the European Securities and Markets Authority. These agencies must comply with transparency requirements, with a particular focus on the methodology and sources of information that they use.
So, how can this legislation benefit investors and ESG consultants? For investors, the new regulation is aimed at improving their confidence and ensuring they are aware of how many of their ESG goals are being fulfilled by a financial product. Considering that investors held $30.3 trillion in sustainable assets in 2022, they must know the product they are buying is supporting the environment. For consultants, the increasing regulation and scrutiny that the ESG sector is facing will mean a massive increase in demand as firms attempt to navigate the increasingly complex legal environment. These regulatory challenges, partnered with increasingly ambitious climate goals set by companies, could mean that the overall sustainability and ESG consulting market will more than double over the next 5 years, reaching a value of $16 billion in 2027, according to the research firm Verdantix.
As the climate emergency worsens, governments are finding new ways to entice investors into attempting to make more money through ESG-conscious means. The increased legislation stands to greatly benefit both consultants and investors by providing the former with more work and the latter with more security. Though the UK and EU are powerful forces when it comes to financial legislation, it remains to be seen whether the US will enforce new regulations of its own to protect ESG investors.