Draft Financial Services and Markets Act 2023 (Prudential Regulation of Credit Institutions) (Consequential Amendments) Regulations 2025
Draft Financial Services and Markets Act 2000 (Regulated Activities) (ESG Ratings) Order 2025
(1 day, 7 hours ago)
General CommitteesRead Hansard Text Read Debate Ministerial Extracts
The Economic Secretary to the Treasury (Lucy Rigby)
I beg to move,
That the Committee has considered the draft Financial Services and Markets Act 2023 (Prudential Regulation of Credit Institutions) (Consequential Amendments) Regulations 2025.
The Chair
With this it will be convenient to consider the draft Financial Services and Markets Act 2000 (Regulated Activities) (ESG Ratings) Order 2025.
Lucy Rigby
It is a pleasure to serve under your chairmanship, Mrs Harris.
I turn first to the environmental, social and governance ratings order, which I note the Secondary Legislation Scrutiny Committee flagged as an instrument of interest in its 41st report. The draft order will bring the provision of ESG ratings within the regulatory perimeter of the Financial Conduct Authority. Regulation will improve standards in the market, boost investor confidence and reduce greenwashing, and it has strong support across the financial sector.
As hon. Members will be aware, ESG ratings are a spectrum of products usually marketed as providing an assessment of the ESG profile, characteristics, risk exposures or impacts associated with a company, fund or other financial instrument. ESG ratings are widely relied on by investors to guide investment decisions in line with sustainability risks, opportunities and preferences. Of the £10 trillion-worth of assets under management in the UK in 2024, half had integrated ESG factors into the investment process. In the UK in 2024, more than 5,400 firms were using ESG ratings.
However, the ESG ratings market has developed rapidly and without formal oversight. This has led stakeholders and users to raise concerns about transparency, governance, internal controls and potential conflicts of interest within ESG ratings providers. Identifying these concerns, the International Organisation of Securities Commissions published recommendations for ESG ratings and data providers, calling for higher standards and sufficient oversight in the sector. The Government have acted quickly to deliver progress on this important agenda.
Chris Coghlan (Dorking and Horley) (LD)
The Liberal Democrats welcome this measure, but what work have the Government done to ensure that the regulation will be in line with that of international regulators such as the Securities and Exchange Commission, to reduce the burden on our businesses?
Lucy Rigby
We remain open to the prospect of regulatory alignment with other regimes. We want to get this done first, but the hon. Gentleman raises an important point.
As I say, the Government have acted quickly to deliver progress. As hon. Members will know, a consultation was issued by the previous Government; this Government have ensured that the consultation response and draft legislation were published for technical comments as part of the Chancellor’s first Mansion House speech. That draft legislation has been refined into the ESG ratings order before the Committee.
The draft order will create a new regulated activity of providing an ESG rating where that rating is likely to influence a decision to make a specified investment. This will require providers of ESG ratings to be authorised and be supervised by the FCA. In recognition of the fact that ESG ratings are provided by a range of different persons, the scope of the regulated activity is designed to be proportionate to the risk of harm, avoiding dual regulation and maintaining consistency with the existing regulatory framework. The draft order contains specific exclusions to that effect, for example where a firm is providing ESG ratings as part of another regulated activity.
To support the integrity of the UK market and ensure a level playing field, ESG ratings that are provided to a UK customer by an overseas provider will fall into the scope of the regulated activity, except where those ratings are provided without remuneration or financial incentive. The Government support open, competitive and internationally connected financial markets, and we therefore intend to give further consideration to market access arrangements for overseas ESG ratings providers.
In the interests of allowing plenty of time for industry to engage, while also delivering a regulatory regime in a timely manner, the FCA launched its consultation on the specific regulations for ESG ratings providers on 1 December, on the basis that the draft order had been laid on 27 October. The FCA rules will be designed to be proportionate and tailored to address harms while protecting innovation, in line with the regulator’s secondary growth and competitiveness objective.
The proposal to bring ESG ratings providers into regulation has received strong support from industry. The move will strengthen market integrity and boost investor confidence, helping the sector to attract new users and providers. The draft order is a core part of the Government’s agenda to drive growth in the UK’s sustainable finance market.
The draft prudential regulation of credit institutions regulations are a technical instrument that makes changes to support reforms to UK banking regulation. The regulations will keep our legislation for financial services effective, and they will assist the Treasury in applying the FSMA model of regulation to set a prudential framework for banks. The regulations do not introduce any new regulatory requirements for firms.
As hon. Members will be aware, banks are required to follow a set of prudential regulations to manage their risk appropriately and maintain adequate levels of capital to protect against any losses. In addition, the biggest banks are required to hold additional loss-absorbing debt to ensure that they can be allowed to fail without the need for taxpayer-funded bail-outs such as those seen during the global financial crisis.
A significant amount of prudential regulation is set out in the capital requirements regulation, or CRR, which formed part of domestic law during our time as an EU member state. Following our exit from the EU, the Government have been tailoring the existing financial services framework to the UK’s needs. That includes the CRR, which will be removed from the statute book and largely restated in the Prudential Regulation Authority’s rulebook, providing more flexibility and allowing the PRA to set the relevant requirements.
To do that, legislation has been passed to revoke the CRR—notably in FSMA 2021 and FSMA 2023. In that context, the Government have brought forward these technical regulations to make a small number of consequential amendments to pieces of legislation that refer to specific CRR articles—specifically, they amend the Banking Act 2009 to ensure that definitions relating to share capital instruments and banks’ own funds reflect the revocation of certain CRR articles.
In summary, although these draft regulations are technical and do not introduce any new rules, they are nevertheless a necessary step in continuing the reform of our banking regulation to ensure that our regulatory framework remains coherent. I commend the regulations to the Committee.
Gareth Davies (Grantham and Bourne) (Con)
It is always a great pleasure to see you in the Chair, Mrs Harris. I will follow the Minister’s lead by starting with the ESG ratings order before moving on to the draft regulations.
The Minister usefully and clearly set out the Government’s view of the ESG ratings order and what it aims to achieve. I want to ask two questions in particular, straight out of the gate. First, although she referred to this slightly in answering the hon. Member for Dorking and Horley, could she go into more depth about the approaches taken in other jurisdictions—particularly the United States and the EU? What are the specific implications for our competitiveness? She mentioned that she is open to alignment with other jurisdictions, and she specifically said that she is open to allowing the ratings of overseas ratings providers to be recognised in this country. But will she address the specific point about competitiveness and where the order stands in the global ecosystem of ESG ratings regulation? It would be helpful to understand that.
Secondly, I understand that in the responses to the consultation concerns were raised about charities being granted an exemption. Is the Minister concerned that charities, and particularly household names, might publish ESG scores against certain companies and sectors that investors take seriously, despite there being a lack of transparency on how those scores were reached? I have taken a particular interest as that legitimate concern stood out from the consultation.
As the Minister considers those answers, it is useful for us to step back as we think about ESG to ensure that, as we scrutinise the draft order, we talk about the overall effectiveness of ESG in supporting the interests of savers and investors in the country. My view, having led an ESG team in my previous life—I think this view is shared by a lot of savers and investors in the industry— is that investment managers should always act with the aim of delivering sustainable returns for investors. From the teacher who has paid into their pension their whole life to the entrepreneur who has just sold their business and invested all their money, many people from all walks of life entrust their money to investment firms and portfolio managers, and they rightly expect financial professionals to uphold their fiduciary responsibilities.
In recent years, however, many, including me, have expressed the view that the rise of ESG has allowed and encouraged some fund managers to impose their own values on investment portfolios, thereby potentially impacting the returns achieved for thousands of investors. Of course, where individuals have enough money for a separate account, or where other retail investors choose to invest in a dedicated ESG fund, that is their choice. They may well pay a premium for not investing in certain industries and be comfortable with that.
Chris Coghlan
The shadow Minister makes an interesting point about the personal views of some fund managers. What is his view on including defence stocks in ESG portfolios, given the change in the geopolitical situation?
Gareth Davies
If the hon. Gentleman will allow me, I will come on to that point. It is a very hot topic right now, in terms of our national security, and I think there are implications when it comes to ESG ratings and the overall ESG approach that many fund managers take.
As I was saying, the overall picture is that there is a risk that everyday savers might miss out on returns because of the values and ideals pursued by a particular fund or fund manager, without their expressed wishes necessarily being taken into account. If we accept, as many do, that this is a problem for funds, it follows that it extends to those who provide ESG ratings, too. Therefore, more transparency, which this measure achieves, could and should help to mitigate the risk for savers.
At a broader level, I have made very clear my personal opinion that ESG has gone too far towards values-driven investing, while neglecting to include our collective national, strategic and economic interest. At a time when the world is increasingly geopolitically unstable, and with an aggressive Russia at the door of Europe, is it really responsible or ethical to shun investment in defence companies?
I believe this mindset undermines our national security effort, but it also means that savers and investors could miss out on better returns. The FTSE 100 index is up around 19% for the year to date, compared with shares in Rolls-Royce, which are up 77%; shares in BAE, which are up 38%; and shares in Babcock, which are up 118%. Those companies form the bedrock of the British defence industry. Over the past year, they would have delivered better-than-average investment returns for savers, but so many savers have been excluded from investing in such companies, perhaps without their knowledge.
Similar national importance could be attached to oil and gas companies and investments. Even the Climate Change Committee has been clear that the consumption of oil and gas will be needed for years to come as part of our energy security. Yet just last week, the National Energy System Operator warned that Britain could face gas shortages by 2030 if the industry—
The Chair
Order. While I appreciate the shadow Minister’s thoughts, could he please keep his speech within the context of our debate?
Gareth Davies
I am grateful for your guidance, Mrs Harris. This is related to ESG, which is about environmental, social and governance principles, and accordingly an investment approach and ratings. I was talking about defence as part of the “S”, and oil and gas as part of the environment.
The Chair
Order. I have to be guided by the Clerk, who fears that we may be going out of scope. I would appreciate it if the shadow Minister kept his remarks to the task in hand.
Gareth Davies
I will end my point by simply suggesting that it is not serving investors or the country well by being excluded from oil and gas companies or defence stocks as part of an ESG strategy that they perhaps did not know about.
I now turn to the draft regulations, which revoke assimilated EU law relating to financial services and replace it with rules set by the Bank of England and the PRA. This is part of an ongoing process to repeal and replace assimilated EU financial services law following our departure from the European Union. The purpose of the draft regulations is largely to revoke the relevant parts of the assimilated prudential regime, as set out in the capital requirements regulation, and replace them with the PRA rules, as the Minister set out.
As the Minister made clear, the draft regulations make consequential technical amendments to UK legislation for the purpose of legal coherence. In practice, any references to revoked CRR provisions will be read as references to the corresponding PRA rules. Where no PRA rule exists, the amendments will help to avoid gaps in the legal framework, with which I think we can all agree. This instrument continues the process begun under the previous Government, as the Minister said, and therefore the Opposition do not oppose it.
Lucy Rigby
I welcome the consensus on the draft regulations. Four principal points were raised in relation to the draft order. The first was on the international position, and the recommendations we are putting in place in this draft order are in line with the IOSCO and OECD recommendations. The EU framework has been legislated for, but it will not come into force until 2026. In many areas of financial services, we have the ability to put in place an overseas recognition regime—an ORR. We do not yet have the ability to do that in relation to this, but we hope to take the power in the next financial services Bill to enable us to bring forward exactly this kind of measure where we wish to do so. The shadow Minister might be aware that Hong Kong, Singapore and Japan have codes of conduct of this nature.
In relation to charities—this is a good point and was considered—the scope of the regulated activity set out in the draft order is designed to be proportionate to the risk of harm. As such, charities will be excluded from regulation where a rating is provided on an occasional or one-off basis, or where there is no remuneration or other financial benefit provided to the charity. As I said, this approach, informed by consultation, ensures that the regulation is risk-based and proportionate while avoiding loopholes.
The shadow Minister also mentioned defence. The Chancellor has stated very clearly her view that supporting the defence industry, and indeed Ukraine, is consistent with ethical investing. The regulation will allow investors to more fairly evaluate ESG risks and opportunities related to defence companies. I should make it clear that we have engaged extensively with the defence sector, and we think there is quite limited evidence that defence firms have struggled to access finance on ESG grounds.
Briefly, the fiduciary duty is important and, as the shadow Minister knows, it has been much discussed. The Pensions Minister will address it further in subsequent stages of the Pension Schemes Bill.
Gareth Davies
I am very grateful to the Minister for outlining the Government’s position on defence stocks. I wonder whether she could do the same for oil and gas.
Lucy Rigby
The point in relation to oil and gas is exactly the same as that for defence. There is no conflict between what we are doing here and investment in those areas. If anything, it will be helpful across the board. Fiduciary duty was the final point raised, so I will leave it there.
Question put and agreed to.
DRAFT FINANCIAL SERVICES AND MARKETS ACT 2000 (REGULATED ACTIVITIES) (ESG RATINGS) ORDER 2025
Resolved,
That the Committee has considered the draft Financial Services and Markets Act 2000 (Regulated Activities) (ESG Ratings) Order 2025.—(Lucy Rigby.)