The European Council has announced that it has agreed on new rules that impose new requirements on ESG rating providers. The new regulations, adopted today, are intended to improve ESG ratings’ credibility and comparability, increasing the trust of investors in sustainable financial products. The move follows an accord with the European Parliament reached before this year and Parliament’s vote last May 2024.
The impetus for regulation of ESG ratings providers began with a letter sent by the European Securities and Markets Authority (ESMA) in 2021, in which the authority expressed its concerns about the lack of regulation in the ESG ratings sector. ESMA expressed risk factors associated with this uncertainty, including the lack of transparency and harm potential to investors. The response of the European Commission was to include measures in the Sustainable Finance Strategy, unveiled in July 2021, promising to step up the reliability, transparency, and comparability of ESG ratings. ESMA then made recommendations for market participants and practices.
In June 2023, the European Commission proposed assigning supervisory authority over ESG ratings providers to ESMA. In a set of stringent requirements for providers of those ratings, it will be obligatory that the ratings providers have objective and rigorous methodologies, prevent conflicts of interest, and improve the transparency methodology, models, and assumptions.
The new law puts ESG ratings providers under the umbrella of ESMA to be authorized and comply with requirements for disclosure of methodologies and sources of information used for rating. Providers outside the EU will have to meet one of three alternatives: get an endorsement from an EU-authorized provider, be recognized based on equivalence between regulatory frameworks, or be included in the EU’s ESG ratings registry.
With these measures, the EU aims to ensure that ESG ratings meet high-quality standards, addressing investor concerns and fostering trust in sustainable finance. The legislation is set to be published in the EU’s Official Journal and will take effect 20 days after publication. Full implementation will occur 18 months later, giving market participants time to align with the new rules.
The EU’s move comes at a time when globally, ESG ratings are going under the scrutiny. This month, the UK released a draft regulation of ESG ratings providers while setting a wider pattern of greater regulation in the sector.