ESG Ratings Regulation: Political agreement reached

In a significant development, the Council and the European Parliament reached a provisional political agreement on 5 February 2024 on the Commission's proposal for a Regulation on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities dated 13 June 2023 (the "ESG Ratings Regulation") (see the Council press release).

The main goal of the ESG Ratings Regulation is to improve the quality, reliability and comparability of ESG ratings. This is to be achieved by increasing the transparency of the characteristics of and methodologies used in ESG ratings. In addition, the ESG Ratings Regulation seeks to ensure clearer insight into the operations of ESG rating providers and to prevent potential conflicts of interest. The overall aim is to facilitate better-informed investment decisions in line with sustainability objectives.

The final version of the ESG Ratings Regulation has not yet been made public, but according to the Council's press release, the following points have been agreed:

1. Authorisation and Supervision: ESG rating providers located in the European Union must obtain authorisation from the European Securities and Markets Authority (ESMA). Similarly, those established outside the EU that intend to operate within its jurisdiction can choose from three regimes: equivalence, endorsement, or recognition. Small ESG rating providers may opt in under a simplified registration regime for three years if they meet specific organizational and transparency criteria. Under the new rules, ESG rating providers will be supervised by ESMA.
2. Supervisory Flexibility: ESMA may exempt small ESG rating providers from certain requirements based on justified cases and business characteristics.
3. Scope and Exclusions: The provisional agreement clarifies the circumstances under which ESG ratings fall within the scope of the ESG Ratings Regulation and which exemptions apply. It also specifies the territorial scope by defining what constitutes "operating in the EU".
4. Marketing Disclosures: Financial market participants and financial advisers disclosing ESG ratings in marketing materials must provide information on the methodologies used in order to enhance transparency for investors.
5. ESG Rating Components: As ESG ratings encompass environmental, social and human rights or governance factors, there will also be the possibility to provide separate or combined ratings with an explicit factor weighting.
6. Separation of Activities: The provisional agreement further introduces a principle of separation of ESG rating activities from other activities, but foresees a possibility for ESG rating providers to integrate certain activities without establishing separate legal entities, subject to a clear separation and conflict of interest mitigation. However, the latter exemption would not apply to ESG rating providers conducting consulting, audit, and credit rating activities.

The provisional agreement is subject to approval by the Council and the Parliament before being formally adopted. The ESG Ratings Regulation will take effect 18 months after its entry into force.

In conclusion, the agreement on the ESG Ratings Regulation marks a significant milestone in promoting sustainable investment and enhancing market integrity in the European Union. By establishing clear standards and oversight mechanisms, the ESG Ratings Regulation aims to foster investor confidence and advance the sustainability agenda in financial markets.