The EU Council and European Parliament have reached an agreement on a new proposal meant to strengthen ESG ratings, including authorization of ESG rating providers by the European Securities and Markets Authority (ESMA) and additional transparency requirements.
A number of rules were determined under the provisional agreement, outlining which ESG ratings will fall under the regulation, including territorial scope.
The agreement explains that companies disclosing ESG ratings in marketing communications have to include methodologies used to create the ratings on their website. It also indicates a possibility for financial market participants to provide separate environmental, social, and governance ratings.
Proposal’s Implications for ESG Rating Providers
A large majority of the proposal involves the regulation of ESG rating providers established in the EU, which will need to obtain authorization from the ESMA to continue operations in the EU within 18 months of the ruling’s establishment. Additionally, ESG rating providers from outside the EU will require an endorsement by an EU-authorized ESG provider or otherwise must be recognized in the registry of ESG rating providers.
In order to assist smaller ESG rating providers, the provisional proposal will allow a three-year, lighter, optional registration regime that will still include regulatory transparency requirements. Under this regime, the ESMA may decide to exempt an ESG provider from certain requirements in special cases.
After initially requiring a separation of business in its original proposal from June of 2023, aiming to avoid conflicts of interest in the rating process, the EU Council later introduced the possibility for ESG rating providers to go without a separate legal entity. With the latest agreement, a separate legal entity will not be required, but a clear separation between business and legal activities must be made clear by ESG rating providers.
Requirements Aim to Improve Investor Confidence in Sustainability Claims
Investors have indicated a lack of trust in companies’ portrayal of their sustainability efforts. A recent survey from PwC indicates that 94% of investors believe that corporate sustainability reporting contains at least some level of unsupported claims.
The EU’s new regulation aims to set a standard for ESG ratings and improve trust with investors, overall strengthening the reliability and comparability of companies’ sustainability claims.
“I welcome this agreement,” said Vincent Van Peteghem, Belgian minister of finance, who helped negotiate the proposal. “Increasing investor confidence through transparent and regulated ESG ratings can have a significant impact on our transition to a more socially responsible and sustainable future.”