Other Author:      Oliver Williams, Trainee Solicitor, Mayer Brown

A lot can happen in ESG in three days. By Wednesday last week, there were three important developments in the world of ESG and sustainable finance from the European Securities and Markets Authority (“ESMA”), the International Capital Markets Association (“ICMA”) and the UK Financial Conduct Authority (“FCA”). We summarise these developments below.

ESMA publish on ESG Ratings
On Monday, ESMA published an overview of the market for ESG rating providers in the EU. Third party ESG ratings are increasingly used by investors to assess, and by corporates to demonstrate, ESG credentials. The publication, in the form of a letter to the European Commission, includes a range of findings in relation to the size, structure and nature of the growing ESG rating market.

Of significant interest will be ESMA’s summary of feedback on the shortcomings of ESG Ratings. Respondents highlighted a lack of coverage across some industries by ESG rating agencies (and particularly for small and medium size enterprises), low levels of transparency of rating methodologies, lack of comparability and low correlation between ESG ratings1, a need for alignment on the definition and purpose of ESG ratings, delays in updating ESG ratings, a “US-bias” resulting from a concentration of US rating providers and concerns about excessive costs and conflict of interests risks in the “issuer-pay” model underpinning the market.

The feedback gives weight to calls across the industry for regulation in this area. As a follow up, ESMA have stated that they will continue supporting the European Commission in their assessment of the need for introducing regulatory safeguards for ESG ratings.

New ICMA resources for the sustainable bond market
On Tuesday, ICMA announced a range of new and updated publications in support of the sustainable bond market. Notably, these include new definitions for green securitisation, an updated registry of key performance indicators (“KPIs”) and Q&A guidance for Sustainability-Linked Bonds (“SLBs”), and new resources for climate transition finance. In particular:

  • Securitisation - ICMA has provided new definitions for green and social securitisation as part of the appendices to each of the Green Bond Principles and Social Bond Principles clarifying terminology and market practice. A Q&A has also been released (including guidance on sustainability criteria relating to collateral, no double counting principles and reporting requirements).
  • SLBs - ICMA has updated its registry of approximately 300 KPIs providing detailed examples to assist market participants in the selection of KPIs. In addition, the existing SLBs Q&A has been expanded with helpful guidance on a range of topics, including:

-  assessing materiality of KPIs;
-  calibration of KPIs;
-  the timing of call dates prior to testing Sustainability Performance Targets (“SPTs”) and, in particular, where a call date is prior to the testing of an SPT, noting that investors will expect the call price to reflect an assumption that the SPT has not been met; and
-  expanded guidance on how changes and amendments to KPIs and SPTs should be dealt with, reflecting trends in the market for issuers to include recalculation or amendment provisions in certain circumstances.

  • Climate Transition Finance - A new Climate Transition Finance Methodologies registry has been created with a list of tools to specifically help issuers, investors, or financial intermediaries validate their emission reduction trajectories as "science-based". Similarly, the Guidelines for External Reviews have been updated to facilitate the assessment of alignment with the existing Climate Transition Finance Handbook.

There are now a multitude of resources available to the sustainable bond market from ICMA. A useful graphical overview of the guidance and toolkits is available here.

FCA views on ESG in the capital markets
On Wednesday, the FCA published Feedback Statement FS22/4 and Primary Market Bulletin 41 clarifying its views on current practice in ESG-labelled debt markets and potential next steps in relation to ESG data and rating providers.

In relation to ESG-labelled debt, the FCA:

  • encourage issuers to consider applying global industry standards, such as ICMA Principles and Guidelines. Note, the FCA have also said there are no concrete plans for a UK Green Bond Standard in the short term;
  • reiterate existing obligations under Article 22 of the UK Prospectus Regulation to ensure that any advertisement is not inaccurate or misleading, and is consistent with the prospectus; and
  • encourage issuers and their advisors to engage verifiers and second party opinion providers who adhere to professional standards, such as ICMA Guidelines for External Reviewers.

In relation to ESG ratings, the FCA mirror many of the concerns set out by ESMA above and:

  • see a clear rationale for regulatory oversight of certain ESG data and rating providers – and for a globally consistent regulatory approach informed by the recommendation developed by International Organisations of Securities Commissions2; and
  • support the UK Government’s consideration of bringing ESG data and ratings providers within its regulatory perimeter.

1 By way of example, the Sloan School of Management at MIT found the correlation among prominent agencies’ ESG ratings was on average 0.61; by comparison, credit ratings from Moody’s and Standard & Poor’s were correlated at 0.92.

2 IOSCO’s recommended key regulatory outcomes in relation to ESG ratings cover: Transparency, Good governance, Management of conflicts of interest and Robust systems and controls