ESG Ratings

Environmental, Social and Governance (ESG) rating activities play an important role in the EU sustainable finance market as they provide information to investors and financial institutions regarding, for example, investment strategies and risk management on ESG factors. ESG ratings have an increasingly important impact on the operation of capital markets and on investor confidence in sustainable products. The market of ESG ratings is expected to continue to grow substantially in the coming years. According to Commission, the current ESG rating market suffers from deficiencies and is not functioning properly, with investors and rated entities’ needs regarding ESG ratings are not being met and confidence in ratings is being undermined. This problem has a number of different facets, mainly (i) the lack of transparency on the characteristics of ESG ratings, their methodologies and their data sources and (ii) the lack of clarity on how ESG rating providers operate. ESG ratings do not sufficiently enable users, investors and rated entities to take informed decisions as regards ESG-related risks, impacts and opportunities. The proposal does not intend to harmonising the methodologies for the calculation of ESG ratings, but to increase their transparency. ESG rating providers will remain in full control of the methodologies they use and will continue to be independent in their choice, to ensure that a variety of approaches are available in the ESG ratings market (i.e. ESG ratings may differ amongst themselves and cover different areas). The Council and Parliament agreed that if financial market participants or financial advisers disclose ESG ratings as part of their marketing communications, they will include information about the methodologies used in such ESG ratings on their website. This was done through an amendment of the Sustainable Finance Disclosure Regulation. The agreement clarifies that ESG ratings encompass environmental, social and human rights or governance factors. 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. ESG rating providers established in the EU will need to obtain an authorisation from ESMA. ESG rating providers established outside the EU that wish to operate in the EU will need to obtain an endorsement of their ESG ratings by an EU authorised ESG rating provider, a recognition based on a quantitative criterion or be included in the EU registry of ESG rating providers on the basis of an equivalence decision in relation to the country of its origin and following a dialogue held between ESMA and the relevant third-country competent authority. Key Objectives: 1/ Enhancing Transparency: The regulation mandates ESG rating providers to disclose their methodologies, ensuring that investors and stakeholders understand the criteria and processes behind ESG ratings.  2/ Ensuring Integrity and Independence: It establishes standards to prevent conflicts of interest, promoting the independence of ESG rating activities and ensuring that ratings are not unduly influenced by external pressures.  3/ Improving Reliability: By setting harmonized standards, the regulation aims to ensure the quality and consistency of ESG ratings, enabling better comparability across different providers and jurisdictions.  Scope and Application: -> ESG Rating Providers: The regulation applies to entities offering ESG rating services within the EU, requiring them to obtain authorization from the European Securities and Markets Authority (ESMA) and adhere to the established standards.  -> Prohibited Activities: To maintain objectivity, ESG rating providers are prohibited from engaging in certain activities, such as developing benchmarks, issuing credit ratings, and providing consulting services to investors or companies.  Expected Impact: -> Investor Confidence: By ensuring that ESG ratings are transparent, reliable, and free from conflicts of interest, the regulation aims to bolster investor confidence in sustainable finance products. -> Market Integrity: The regulation seeks to enhance the overall integrity of the EU financial markets by providing clear and consistent information on ESG factors, thereby supporting informed investment decisions. -> Alignment with Global Standards: The EU’s initiative positions it as a leader in regulating ESG rating activities, potentially influencing global standards and practices in sustainable finance. 🔗 EP, EC, European Commission Finance