The European Union Council has agreed on its negotiating mandate for the regulation of ESG ratings, aiming to strengthen the reliability and comparability of ratings and to boost investor confidence.
ESG ratings are commonly used to provide insight into a company’s sustainability profile. Rating providers evaluate companies based on various sustainability metrics, with data taken from corporate disclosures, conduct management interviews, and other publicly available information.
With the new EU ruling, ESG rating providers will be authorized and supervised by the European Securities and Markets Authority (ESMA) and will comply with specific transparency requirements, especially regarding their rating methodologies and information sources.
As part of the new mandate, ESG rating providers operating in the EU will have to obtain authorization from the ESMA or an equivalent party if operating outside the EU. Smaller ESG rating providers and new small market entrants will reportedly have three years to comply with a lighter registration regime.
The initial proposal for the ESG rating regulation included a call for separation of business in order to prevent conflicts of interest in the rating process. With the new agreement, the EU Council introduced the possibility for ESG rating providers to go without having a separate legal entity for certain activities, but this would not apply to consulting or auditing activities provided to rating entities.
As investors and consumers become more concerned with companies' sustainability claims, an increasing number of regulations have been established to improve corporate accountability.
The EU has released a number of rules in the past couple of months alone. The EU council agreed upon an update to its ecodesign regulations, banning the destruction of unsold products and requiring the steel, textile, furniture, tire, and chemical product industries to fully inform consumers of the environmental impact of a given purchase. The EU also released legislation meant to reduce methane emissions by 55% by 2030 and has since received support from multiple oil and gas producers that reportedly aim to follow the new guidance.
With a recent PwC survey showing that about 94% of investors are unlikely to believe corporations’ sustainability claims in their entirety, increased regulation of corporate ESG ratings may present a promising step towards evolving reliability measures in the sustainable finance sector.
