FCA Report on Company and Investor Views on ESG Ratings

The Financial Reporting Council (FRC) has released a report showing that that public companies and their investors have different views on the importance of ESG ratings and their use.

A low ESG rating has so far not been a significant consideration for most companies in setting their strategy and action plan and tackling ESG issues. The report also shows that most investors use ESG rating agencies as a source of data rather than relying on the rating itself in their decision making.

A second report by the FRC studies the approach of chairs of corporate audit committees to ESG reporting and activities. The report found that audit committee chairs have a keen interest and understanding of ESG issues within their company. However, their role is primarily concerned with risk management and compliance and their involvement in decision making in limited.

The research, based on FTSE 350 companies, asset managers and owners, examined the use and relationships of companies and their investors with proxy advisors and ESG rating agencies and found some “notable differences” and assessed the influence of each, separately.

Their findings are:

1. Proxy advisors were used by almost all investors, and it was found that

2. Most companies provided information used by rating agencies in their methodologies, in order to positively influence their ESG rating. This was due to companies being concerned that investors would rely on ESG ratings in their voting decisions.

3. Most investors indicated they primarily used ESG rating agencies as a source of data rather than relying on the rating itself to inform their voting decisions. Some investors even had developed their own rating systems.

4. The report also highlights concerns raised about the data-gathering techniques used by some ESG rating agencies and data providers, in particular, the use of data scraping and controversy reports. The timing of ESG rating agencies’ rating and research report updates did not always align with reporting and voting cycles.

5. Both companies and investors would welcome greater transparency on the methodologies used by ESG rating agencies.

The research also found some audit committee chairs feel that over the last two years, the environmental portion of ESG has been prioritised over other areas, while the social component is gaining importance.

Some audit committee chairs also felt that the scope of ESG is “too broad” and evolving too quickly, which make a meaningful measurement of ESG performance increasingly difficult, and ESG reporting is making annual reports too long and difficult for investors to navigate.

The FCA reports follow the U.K. government’s consultation, launched in March, which seeks proposals to regulate ESG ratings providers. The European Commission has already drafted a regulation, subject to the legislative process requiring greater transparency and integrity of ESG ratings.

Dr Jacqueline Faridani

Dr Jacqueline Faridani heads up Prospect Law’s fast growing ESG practice. She is an advisor in financial risk management with 20 years of experience in a variety of risk management, compliance and product control roles at Canadian, German, French and Russian banks and life insurance companies, as well as for the Canadian financial regulator (OSFI).

Prospect Law is a multi-disciplinary practice with specialist expertise in the energy and environmental sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, surveyors and finance experts.

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