EU Council and Parliament Reach Consensus on ESG Ratings Regulation to Enhance Investor Trust
February 6, 2024
In a landmark move, the EU Council and Parliament have established a provisional agreement on the new regulatory framework for Environmental, Social, and Governance (ESG) rating activities. This decisive step is anticipated to bolster investor confidence in sustainable products by enhancing the transparency and reliability of ESG ratings.
ESG ratings play a pivotal role in capital markets, influencing investor trust and operational decisions by providing insights into a company’s sustainability profile. These ratings evaluate a company’s exposure to sustainability risks and its impacts on society and the environment.
Vincent Van Peteghem, the Belgian Minister of Finance, hailed the agreement: “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.”
The newly proposed rules are expected to fortify the credibility and comparability of ESG ratings. This is to be achieved by mandating ESG rating providers to become authorised and supervised by the European Securities and Markets Authority (ESMA) and to adhere to stringent transparency requirements concerning their methodology and information sources.
The Council and Parliament have specified the conditions under which ESG ratings fall within the regulatory scope, including applicable exclusions and the definition of operating within the EU. Additionally, the agreement mandates that financial market participants and advisors must disclose the methodologies behind the ESG ratings used in their marketing communications.
One notable feature of the agreement is the possibility to issue separate ratings for environmental, social, human rights, or governance factors. Providers that choose to issue a singular rating must explicitly disclose the weighting of these factors.
ESG rating providers within the EU will now require authorisation from ESMA. Providers from outside the EU must either obtain endorsement from an authorised EU provider, meet a quantitative criterion, or be included in the EU registry following an equivalence decision.
To accommodate small-scale ESG rating providers, a temporary and optional registration regime will be introduced, exempting them from ESMA supervisory fees and subjecting them to general organisational and governance principles.
The provisional political agreement awaits formal approval by the Council and the Parliament before undergoing the official adoption process. The regulation will come into effect 18 months post-enactment.
This regulation comes on the heels of the Commission’s proposal from June 13, 2023, which outlined the supervision of ESG rating providers, conflict of interest management, organisational requirements, transparency obligations, and operational conditions for third-country providers.
The EU's move to regulate ESG rating activities reflects a growing awareness of the importance of sustainability in investment decisions. It signals a shift towards greater corporate accountability and represents a significant step in ensuring that sustainable investment is both impactful and credible. The hope is that with regulated ESG ratings, investors can make more informed decisions that align with a sustainable future, and companies will be incentivized to improve their ESG practices.
