ESG Ratings Providers Set to be Regulated at EU Level

EU member states have reached agreement that will pave the way for ESG rating providers to be authorised and supervised by the European Securities and Markets Authority (ESMA) and comply with transparency requirements, notably in regard to their methodology and sources of information.

Negotiators at the European Council, the EU institution which represents EU member state heads of state, reached agreement in late December for negotiations on the final text of the legislation to begin with other EU institutions, notably the European Parliament.

Under the original proposal put forward in June by the European Commission, which under the EU system of governance, has the sole right to initiate legislation, ESG rating providers would need to be authorised and supervised by ESMA and subject to a range of new rules. The Commission proposed as part of its Regulation on the Transparency and Integrity of Environmental, Social and Governance (ESG) Rating Activities, that ESG ratings providers  not only be authorised and supervised but have to separate their business from ratings activity to prevent conflicts of interest, disclose information to the public as to their ratings methodology, and disclose fees and related requirements. If a ratings provider is based outside the EU, it could operate in the EU under an equivalence regime.

In the current negotiations, the European Council added some provisions and proposed some exemptions. It proposed that in line with the recently passed Corporate Sustainable Reporting Directive (CSRD), which expanded the scope of ESG and climate reporting obligations for companies, the definition of ESG ratings would encompass environmental, social and human rights or governance factors. It also introduced a temporary and optional registration regime, giving existing small ESG rating providers and new small market entrants three years to fully comply, although they would still have to comply with the transparency requirements and be subject to ESMA information requests and be subject to its investigation powers 

In respect to the need for ESG ratings providers to have separate business and ratings activities, the Council introduced the possibility of an exemption, provided that there is a clear distinction between activities and that providers put in place other measures to avoid conflicts of interest.  

Negotiations in the European Parliament will begin in January 2024.

The proposed text following the Council negotiations is here.

An Impact Assessment on the Commission’s original proposal is here.