The European Council has unanimously voted to adopt new regulation on environmental, social and governance (ESG) rating activities, in a move to make such activities more consistent, transparent and comparable.
ESG ratings are designed to provide an opinion of a company’s or a financial instrument’s sustainability profile, by assessing its impact on society and the environment and its exposure to risks associated with sustainability issues. However, critics have suggested that, though rating providers convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies and incentives that detract from how informative their assessments can be.
According to the EU’s new regulations, ESG rating providers established in the Union will now need to be authorised and supervised by the European Securities and Markets Authority (ESMA) and comply with transparency requirements – disclosing the methodology, models and key rating assumptions as a minimum.
Separate E, S and G ratings should be provided and, if a single ESG rating is provided, rating providers will be required to disclose the rate and weight attributed to each dimension.
The regulation also introduces, as a principle, a separation of business and activities in order to prevent conflicts of interest.
Ratings agencies that are found to have intentionally or negligently infringed the regulation can be fined up to 10% of their total annual net turnover.
The regulation will be published in the EU’s Official Journal and enter into force 20 days later. The regulation will start applying 18 months after its entry into force.
Ensuring companies ‘are not penalised by opaque ratings’
The move comes after UK chancellor, Rachel Reeves, announced the publication of a draft statutory instrument on ESG ratings regulation for technical comments in her Mansion House speech. Similar to the European legislation, affected ESG ratings providers will need to obtain authorisation from the UK Financial Conduct Authority (FCA) and comply with the regulatory regime, as prescribed by the FCA.
“Bringing ESG ratings providers into regulation will boost investor confidence, reduce greenwashing and address the lack of transparency highlighted in responses to the government’s consultation. This will help to drive investment, support innovation and ensure that companies in critical sectors are not penalised by opaque ratings,” the government said.
The FCA said it welcomed the proposals and, once the legislation is finalised by the government next year, it intends to consult on proposals for the future regulatory regime in 2025.
“We support a globally consistent approach that enables users to make better-informed investment decisions and gives the market confidence in the reliability and quality of these products,” the FCA commented. “Our regime will be proportionate and in line with the International Organisation of Securities Commission recommendations, which focus on transparency, good governance, managing conflicts of interest and proper systems and controls.”
