ESMA Tightens ESG Rules And Reporting Oversight

The European Securities and Markets Authority (ESMA) has moved one step closer to enhancing EU-wide transparency and consistency of environmental, social, and governance (ESG) information. Through two significant regulatory updates brought forth in early 2025, ESMA is set to transform the way ESG ratings are provided and the way sustainability disclosures are applied, directly affecting ratings providers and EU issuers.

In the wake of the adoption of the ESG Ratings Regulation in late 2024, ESMA has published its draft Regulatory Technical Standards (RTS), outlining a strict framework for ESG ratings providers in the European Union. These draft standards are a collective step towards strengthening investor confidence by doing away with the opacity and inconsistency that have hitherto characterized ESG assessments. At the center of the new regulation is the mandating of all ESG ratings companies to apply for formal authorization and be supervised, thus ensuring higher responsibility in the rapidly changing ESG space.

The consultation paper RTS includes the detailed requirements of the authorisation process, requesting ratings providers to make comprehensive disclosure of methodologies and data sources adopted in their ESG analysis. By seeking increased transparency and public disclosure of the assumptions, models, and sequencing applied to ratings, the rule aims to improve the interpretability and utility of ESG scores for investors and stakeholders.

One of the most significant features of the rule is its strong conflict-of-interest management. In recent years, there has been increasing worry that ESG ratings providers tend to provide consultancy or advisory services in addition to their rating functions, which can introduce biases in their assessments. Although early drafts by the European Commission proposed banning such dual functions outright, the final regulation permits them—subject to firms putting in place operational separation between their rating and non-rating businesses. ESMA's draft RTS is explicit that this separation has to be more than a matter of legal form and has to be substantively enforced to avoid undue influence or manipulation.

A public consultation on the draft RTS is open until June 20, 2025. Following consideration of stakeholder input, ESMA intends to finalize and submit the report to the European Commission by October 2025. Upon implementation, these rules are expected to raise the quality, credibility, and independence of ESG ratings, thus allowing investors to make more informed decisions in accordance with their sustainability objectives.

In addition to the new regulation for ratings providers, ESMA has also published Guidelines on Enforcement of Sustainability Information, which mark a revolutionary change in the way sustainability disclosures are supervised and enforced in the EU. The guidelines aim to align the supervision of sustainability reporting with the established practices applied in financial reporting supervision.

In the new framework of enforcement under which national competent authorities (NCAs) throughout EU Member States are to enhance supervisory function and ensure corporations remain in conformity with the Corporate Sustainability Reporting Directive (CSRD) and EU Taxonomy Regulation, supervision shall be risk-based, i.e., corporations to which there is more exposure of greenwashing, as well as corporations that disclose more important sustainability effects (based on the principle of double materiality), shall face more strict monitoring.

One of the primary emphases of these guidelines is on fighting greenwashing—a strategy in which companies exaggerate or mislead on their environmental performance to receive positive public or investor opinion. ESMA has asserted that enforcement authorities should take action firmly against such abuse. Even slight misstatements in sustainability reporting, if discovered to be knowingly misleading, would trigger reissuance of reports or corrective disclosures.

Apart from discouraging greenwashing, ESMA's coordination within Member States will discourage regulatory arbitrage, where businesses take advantage of variations in national rules to sidestep rigorous compliance. This harmonized model of enforcement is designed to provide a level playing field throughout the EU and ensure high standards of sustainability information.

To businesses within the EU, these developments mark a new age of ESG transparency. Boards and senior leadership teams will have to strengthen internal governing frameworks, strengthen audit and verification processes, and align their ESG strategies completely with changing regulatory definitions and requirements. The onus to prove strong and credible ESG performance will increase, and non-compliant businesses could suffer reputational loss and regulatory sanctions.

As the regulatory environment continues to shift, these new ESMA initiatives highlight the EU's determination to embed sustainability at the heart of financial markets. With more transparent rules, more robust supervision, and an emphasis on transparency, the ESG ecosystem in Europe is being transformed to enable more trustworthy data, lower investor risk, and drive the shift toward a sustainable economy.