Lawmakers from the European Parliament and the Council announced today that they have reached a provisional agreement on a proposal to regulate ESG ratings providers and introduce rules to increase the reliability and comparability of ESG ratings and avoid providers' conflicts of interest.
The new regulation would place ESG rating providers under the authority of the European markets regulator, ESMA, with providers required to be authorized and supervised by the regulator and comply with transparency requirements in areas including methodologies used for ratings and sources of information. .
The new agreement comes as pressure increases to regulate providers of ESG ratings and data, with demand for the services increasing as investors increasingly integrate ESG considerations into the investment process, while the activities and businesses of Providers are generally not covered by securities markets and regulators. .
In early 2021, ESMA issued a letter to the European Commission's financial services coordinator, Mairead McGuinness, advising that the current unregulated state of the ESG ratings sector and the resulting lack of transparency represented a potential risk to investors. In July 2021, the Commission launched a new Sustainable Finance Strategy, which included a commitment to take action to improve the reliability, comparability and transparency of ESG ratings, and subsequently asked ESMA to start vetting market participants.
In June 2023, the European Commission released a proposal for ESG ratings providers to be supervised by ESMA, to ensure quality and reliability, with requirements including the use of rigorous and objective methodologies, prevention of conflicts of interest and greater transparency in rating methodologies, models and main assumptions.
Key aspects of the new agreement between the Council and Parliament include clarifications on ESG ratings that fall within the scope of the regulation, including ratings that cover environmental, social and human rights or governance factors.
The new regulation would require ESG rating providers established in the EU to obtain an authorization from ESMA, and those established outside the EU would have to be approved by an EU-authorized provider, recognized based on quantitative criteria or subject to an equivalence decision based on dialogue between the authorities of the suppliers' country of origin and ESMA, to operate in the EU.
The agreement also introduced an optional 3-year registration regime for small ESG rating providers, including exemption from ESMA supervisory fees and lighter compliance and transparency requirements, but with full compliance and supervision fees after the end of the 3 years.
While the Commission's proposal requires the separation of certain business activities from ESG ratings, and rating providers are not authorized to provide these activities, the agreement allows providers not to create separate legal entities for some activities, as long as there is a clear separation between these activities and the ESG ratings business, as well as measures implemented to avoid potential conflicts of interest, although these exceptions do not apply to ESG ratings providers that offer consulting, auditing and credit rating activities.
Additional aspects of the new rules include the ability for suppliers to offer separate environmental, social and governance ratings, but the requirement to detail the weights of the 'E,' 'S' and 'G' factors if a single rating is provided, and a requirement that financial advisors who disclose ESG ratings as part of their marketing communications include information about the methodologies used for the ratings on their website.
With the provisional agreement reached, the new rules will have to be formally adopted by the Council and the EU Parliament before they officially come into force and will begin to be applied 18 months later.
