ESG ratings: Council and Parliament reach agreement
On February 5, the European Parliament and the Council took an initial provisional decision on the regulation of ESG ratings. But what exactly are ESG ratings? And what direction is the regulation taking?
ESG ratings
An ESG rating or ESG assessment measures a company's exposure to environmental, social and governance risks. Some ratings also assess companies according to their impact on the environment.
ESG ratings help investors to identify and understand financially relevant ESG risks at security and portfolio level. The ratings are based on different approaches, but mostly on a two-dimensional approach that measures both the exposure of a company to industry-specific risks and the quality of a company's risk management.
Background
ESG ratings are currently still a black box. There is no standardized approach, which makes it difficult to compare the ratings. In some cases, there are large discrepancies between the individual rating schemes, which means that companies perform very well in some ratings and are rated significantly lower in others (often based on an ESG score). In addition, some ESG ratings give the impression that companies operate in a particularly sustainable manner, although this is not always the case. Supervisory authorities such as ESMA are therefore calling for greater regulation of the industry, as the market has been largely unregulated to date. The EBA is also explicitly calling for ESG ratings/scores to be taken into account in the lending business in the current MaRisk. In the European Union, there are already initial discussions about stronger regulation of the various ratings, primarily due to the growing importance of ESG ratings.
EU regulatory proposal
On June 13, 2023, the European Commission published an initial proposal for a regulation "on the transparency and integrity of environmental, social and governance (ESG) rating activities". In December 2023, the Council of the EU agreed on a negotiating mandate on ESG ratings. The provisional agreement now published on a proposal for the regulation of ESG ratings is the product of this agreement.
The new rules are intended to increase the reliability and comparability of ESG ratings by improving the transparency and integrity of ESG rating providers' activities, making ratings more comparable and avoiding potential conflicts of interest. Above all, ESG rating providers should meet a number of transparency requirements, particularly with regard to methodology and sources of information, and publish these on their website. The involvement of ESMA, which will authorize and supervise ESG rating providers in the future, is essential from the EU's point of view. Non-EU agencies wishing to operate in the EU will also require confirmation of their ESG ratings by an ESG rating provider authorized in the EU, recognition on the basis of a quantitative criterion or inclusion in the EU register of ESG rating providers. However, smaller ESG rating providers are not expected to pay supervisory fees to ESMA, but will have to comply with general organizational and governance principles and transparency requirements vis-à-vis the public.
Another major problem identified by the EU is conflicts of interest within ESG rating agencies. Many providers of ESG ratings also offer other services such as credit ratings, benchmarks or investment advice. The current proposal provides for a separation of business areas, including measures to reduce conflicts of interest. In addition, the EU requires the development of procedures and processes to monitor, manage and disclose potential conflicts of interest.
The provisional political agreement must still be approved by the Council and Parliament before the formal adoption procedure can be initiated. The regulation will enter into force 18 months after its entry into force.
We support you with all requirements relating to upcoming and existing ESG regulations. Do you have questions about the integration of sustainability data or the identification of ESG risks? Contact us personally at: www.curentis.com
