European Commission to Regulate ESG Rating Providers
Today, in an effort to further enhance sustainability practices the European Commission has proposed a new regulation that seeks to foster greater transparency and regulatory scrutiny in the Environmental, Social, and Governance (ESG) ratings industry. This development marks a crucial step in ensuring accurate and reliable ESG information for investors, companies, and stakeholders. The proposed regulation aims to address concerns surrounding the quality and reliability of ESG ratings, which play a pivotal role in guiding investment decisions and corporate sustainability strategies. By subjecting ESG ratings providers to greater regulatory scrutiny, the European Commission hopes to establish a robust framework that instills credibility, accountability, and transparency in the industry.
The EU has achieved a great deal to promote sustainable finance over the years. Today we are going even further in completing the regulatory landscape to help generate much-needed investments for sustainable growth. It is essential that the rules and instruments in place are coherent, user-friendly and work effectively on the ground. At the same time, we want to ensure that all companies can get finance to invest in their transition to sustainability. This is also important to increase the long-term competitiveness of Europe’s companies and economy and to fight climate change. — Valdis Dombrovskis, Executive Vice-President for an Economy that Works for People
Photo by Gabrielle Henderson on Unsplash
Understanding the Regulation:
According to the EU’s draft legislation, currently, the ESG ratings market lacks transparency and therefore reliability. To address these issues, this regulation has laid out the following rules or policies:
This proposal outlines specific principles and clear rules to prevent conflicts of interest and thus increase the integrity of the operations of ESG rating providers. It will also require that ESG rating providers are authorized and supervised by the European Securities and Markets Authority (ESMA), which includes providing essential information about their methodologies, data sources
ESG ratings providers will need to ensure that their methodologies are robust, consistent, and transparent across the board. They must disclose the key components of their rating models, methodologies for evaluating different ESG factors, and any potential limitations or biases to ensure full transparency and accountability.
The regulation also proposes the use of third-party verification and validation mechanisms. This process will help address concerns related to data quality, methodology, and potential conflicts of interest like paying for ratings.
Finally, the regulation emphasizes the need for standardized ESG ratings, allowing for better comparability across different ratings providers. This standardization will enhance the effectiveness of ESG data in guiding investment decisions and encourage the alignment of sustainability strategies across companies.
With these proposed regulations the hope is that investors, companies, and ESG ratings providers will all benefit at the end of the day. Investors will get the necessary assurance they are making informed decisions based on sustainability objectives. Companies will have standardization and clear benchmarks to assess their Sustainability and ESG performance, which will ultimately help to align strategies and clearly communicate the necessary information to stakeholders and investors. ESG ratings providers can use this new regulation as an opportunity to showcase their commitment to quality and transparency. Providers that align with the new regulatory requirements and demonstrate robust methodologies will gain a competitive edge and establish themselves as trusted partners in the sustainability ecosystem.
We have the foundations of the sustainable finance framework in place. Now is time to build on them. Today we are taking steps to further develop the EU Taxonomy. And we are bringing more transparency and integrity to the market by introducing rules on the operations of ESG rating agencies. Enhancing the usability and coherence of the sustainable finance framework will be our key priority. We also need to reap the full potential of transition finance to ensure that all companies irrespective of their starting points can have adequate tools and support for their transition efforts towards sustainability. — Mairead McGuinness, Commissioner for Financial Services, Financial Stability and Capital Markets Union
Photo by John Schnobrich on Unsplash
Sources:
"European Commission proposes rules to clarify ESG ratings" (Pensions & Investments) Source: Pensions & Investments. (n.d.). European Commission proposes rules to clarify ESG ratings. Retrieved from https://www.pionline.com/esg/european-commission-proposes-rules-clarify-esg-ratings#:~:text=The%20European%20Commission%20is%20set,said%20in%20a%20news%20release.
"Commission proposes measures to improve the reliability of ESG ratings" (European Commission Press Corner) Source: European Commission Press Corner. (2023, June 13). Commission proposes measures to improve the reliability of ESG ratings. Retrieved from https://ec.europa.eu/commission/presscorner/detail/en/ip_23_3192
"EU proposes greater regulatory scrutiny of ESG ratings providers" (Reuters) Source: Reuters. (2023, June 13). EU proposes greater regulatory scrutiny of ESG ratings providers. Retrieved from https://www.reuters.com/sustainability/eu-proposes-greater-regulatory-scrutiny-esg-ratings-providers-2023-06-13/
