ESG Rating Transparency and Integrity Regulation

Introduction

Regulation (EU) 2024/3005 on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities establishes a harmonized regulatory framework for ESG rating providers operating within the European Union. As part of the EU's broader Sustainable Finance framework and the European Green Deal, this regulation aims to improve the reliability, comparability, and transparency of ESG ratings, which have become critical tools for investors and financial institutions.

Main Goal

The primary objective is to strengthen the integrity and functioning of the internal market by introducing rules on the transparency of ESG rating characteristics and methodologies, and by ensuring the independence and prevention of conflicts of interest for ESG rating providers.

Who It Applies To

This Regulation applies to ESG Rating Providers operating in the Union.

Providers are considered to be operating in the Union if they:

• Are established in the Union and publish ratings on their website or distribute them by subscription to regulated financial undertakings or specific EU companies.
• Are established outside the Union and distribute ratings by subscription to regulated financial undertakings or specific EU companies in the Union.

Exemptions

The regulation explicitly excludes:

• Private ESG ratings not intended for public disclosure.
• Ratings used exclusively for internal purposes or in-house financial products.
• Credit ratings issued under Regulation (EC) No 1060/2009.
• Second-party opinions on green bonds (unless they contain ESG ratings).
• Ratings by central banks or public authorities for non-commercial purposes.
• Investment research (MiFID II definition).
• Non-profit organizations issuing ratings for non-commercial purposes (unless they charge fees).

Key Provisions

Authorization and Supervision

• ESG rating providers established in the EU must be authorized by the European Securities and Markets Authority (ESMA).
• Third-country providers must operate via equivalence, endorsement, or recognition regimes.

Transparency Requirements

• Providers must disclose methodologies, models, and key rating assumptions to the public and to subscribers.
• Disclosures must indicate if the rating addresses financial risk, impact materiality, or both (Double Materiality).
• Providers must issue separate Environmental (E), Social (S), and Governance (G) ratings rather than a single aggregated metric, or explicitly disclose the weighting of each factor if aggregated.

Independence and Conflicts of Interest

• Strict separation of business activities: ESG rating providers are prohibited from providing consulting activities, statutory audit, credit ratings, or benchmark administration (with some exceptions) from the same legal entity to avoid conflicts of interest.
• Employees involved in rating determination must be independent and free from undue influence.

Quality and Reliability

• Methodologies must be rigorous, systematic, independent, and capable of justification.
• Methodologies must be reviewed at least annually.

Obligations & Requirements

For ESG Rating Providers:

• Authorization: Submit an application to ESMA containing all necessary operational and ownership information.
• Governance: Establish a permanent and effective oversight function.
• Record Keeping: Maintain records of ratings, methodologies, and fees for at least five years.
• Disclosure: Publish methodologies on websites and the European Single Access Point (ESAP).
• Notification: Notify rated entities at least two working days before the first issuance of a rating to allow for factual error correction.
• Complaints Handling: Implement procedures for receiving and investigating complaints.

Penalties

ESMA has the power to impose supervisory measures, including:

• Withdrawing authorization.
• Temporary prohibition of rating distribution.
• Fines: Up to 10% of the total annual net turnover of the ESG rating provider for intentional or negligent infringements.
• Periodic Penalty Payments: Up to 3% of the average daily turnover to compel compliance.