European Council and parliament reach agreement on ESG ratings regulation

The European Council and Parliament reached a provisional agreement on regulating ESG rating providers. The objective is to enhance investor confidence in sustainable products by improving transparency and reliability in ESG ratings.

Understanding ESG Ratings

In a nutshell, ESG ratings assess the sustainability profile of a company or financial instrument, considering its exposure to sustainability risks and its impact on society and the environment.

Key Regulatory Measures

This new regulation will require EU-based ESG rating providers to be authorised and supervised by the ESMA (the European markets regulator) and to adhere to measures promoting transparency and reducing conflicts of interests.

Clarity on Regulation Scope

The proposal clarifies the circumstances and territorial scope of the regulation, defining when ESG ratings fall within its scope and what constitutes operating in the EU.

It is worth noting that the proposal includes alternate or lighter requirements for:

1. non-EU ratings providers to operate in the EU (such as obtaining endorsement by an EU-authorised ESG rating provider or being included in the EU registry of ESG rating providers subject to an equivalence decision) and
2. small ESG ratings providers, which may opt for a temporary 3-year regime enabling them to benefit from supervisory fees proportional to the extent of ESMA's supervision.

Importance of Transparency

Transparency is central for financial market participants or advisers disclosing ESG ratings. Any marketing communications involving ESG ratings must include detailed information about methodologies on respective websites, offering stakeholders a comprehensive understanding.

Flexibility in Rating Factors

The proposal introduces the flexibility to provide separate or combined E (environmental), S (social), and G (governance) ratings. The weighting of these factors, if presented as a single rating, must be explicitly stated.

Next steps and Implementation Timeline

Formal adoption by the EU Council and Parliament is pending, with the rules expected to be implemented 18 months later.