Lawmakers in the European Parliament and Council have reached a provisional agreement on regulating ESG rating providers, aiming to enhance the reliability and comparability of ESG ratings while addressing conflicts of interest.
Under the proposed regulation, ESG rating providers would fall under the European Securities and Markets Authority (Esma), necessitating authorisation and supervision by the regulator and adherence to transparency requirements regarding methodologies and information sources.
In early 2021, ESMA expressed concerns to the EU Commission about the unregulated ESG ratings sector, citing risks to investors. In July 2021, the Commission initiated a Sustainable Finance Strategy promising action to enhance reliability and transparency in ESG ratings. By June 2023, the Commission proposed ESMA oversight of ESG ratings providers to enforce rigorous methodologies, prevent conflicts of interest, and enhance transparency.
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Key elements include specifying the types of ESG ratings covered, mandating EU-based providers to obtain ESMA authorisation and outlining criteria for non-EU providers to operate in the EU.
Non-EU ESG rating providers must either secure endorsement from an EU-authorised provider, meet quantitative criteria for recognition, or gain inclusion in the EU registry based on an equivalence decision following dialogue between ESMA and the relevant third-country authority.
Additionally, the agreement introduces a 3-year optional registration scheme for small ESG rating providers, offering exemptions and lighter compliance requirements initially. However, full compliance and supervisory fees would apply after the 3 years.
According to the European Council: “The agreement foresees the possibility to provide separate E, S and G ratings. However, if a single rating is provided, the weighting of the E, S and G factors should be explicit.”
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While the proposal initially mandated separation of certain business activities from ESG ratings, exceptions allow integration as long as clear separation and conflict of interest measures are in place. The rules also mandate detailed disclosure of ESG rating methodologies by financial advisers using ESG ratings in marketing.
Formal adoption by the EU Council and Parliament is required before the rules officially come into effect, with implementation expected 18 months thereafter.
