ESG rating providers will have to seek approval to ensure they meet transparency requirements under rules provisionally agreed this week by the European Council and European Parliament.
Lawmakers announced on February 5 that they had reached an agreement on the regulation of ESG rating activities to increase confidence in sustainable products: providers of ESG ratings will have to pay to be authorized and supervised by the European Authority for Securities and Markets (ESMA) to ensure they meet the requirements. particular attention to their methodology and information sources. Once formally adopted, the regulation will enter into force in 18 months rack said.
The rules are intended to strengthen the reliability and comparability of ESG ratings, the statement said, by improving the transparency and integrity of the activities of ESG rating providers and preventing potential conflicts of interest.
See also: – ESG ratings providers should prepare to jump through regulatory hoops after latest EU proposals
Into the details
In particular, where financial market participants or financial advisors disclose ESG ratings as part of their marketing communications, they will be required to include information on the methodologies used in such ESG ratings on their websites.
Looking ahead, the parties said they “envisage the possibility of providing separate E, S and G ratings” and “if a single rating is provided, the weighting of the E, S and G factors should be explicit ”.
A principle has also been introduced to ensure that there is a clear separation between certain activities to avoid potential conflicts of interest.
“The agreement introduces as a principle a separation of activities and activities, with the possibility for ESG rating providers not to establish a separate legal entity for certain activities, provided that there is a clear separation between the activities and that they take measures to avoid potential conflicts of interest,” the statement said.
“However, this derogation would not apply to ESG rating providers that undertake advisory, audit and credit assessment activities. ESG rating providers may nevertheless develop benchmarks if ESMA considers that sufficient measures have been taken to address conflicts of interest.”
EU-based ESG rating providers will need to obtain a license from ESMA and non-EU providers wishing to operate within the EU will need to obtain an approval of their ESG ratings by an EU authorized ESG rating provider . This is a recognition based on a quantitative criterion or inclusion in the EU register of ESG rating providers based on an equivalence decision.
A “lighter, temporary and optional registration regime” has also been introduced for smaller groups – these will be exempt from paying supervisory fees to ESMA and will have to comply with lighter compliance, but must fully comply after three years.
Vincent Van Peteghem, the Belgian Minister of Finance, commented: “I welcome this agreement. Increasing investor confidence through transparent and regulated ESG ratings can have a significant impact on our transition to a more socially responsible and sustainable future.”
Raza Naeem, financial regulatory partner at Linklaters, said the developments were “another important milestone”.
“The EU proposals go far beyond any other regimes we have seen internationally – given the very broad scope proposed for ‘ESG ratings’ (which could include ESG products that do not fall within the traditional understanding of ESG ratings) (although some useful exceptions have been introduced to limit the impact of the segregation rules).
“Non-EU ESG rating providers will also be subject to these rules and will have to jump through certain hoops to provide their ratings in the EU (approval by an authorized EU ESG rating provider, recognition or equivalence by ESMA or setting up an EU rating organisation). authorized ESG rating provider).
“Overall, today’s announcement represents an important development not only for EU ESG rating providers, but also for their users, who in some cases (for example if subject to SFDR) will be required to provide disclosures about the ESG ratings used and/or will indirectly benefit from increased regulation of their ESG rating providers.”
Naeem’s colleague Premlata Fagan, managing associate in financial regulation at Linklaters, said they were waiting for the final text to understand exactly what was agreed – especially on the “most controversial elements of the trialogue talks”.
“This includes: whether the original proposal that there should be no interference with the content of ESG ratings or methodologies has remained intact; whether Parliament has succeeded in including conditions around the use of multiple providers of ESG ratings; what turnover threshold has been set for third country rating providers; and the extent to which internal ratings of financial products will be covered by the final rules.
“What we do know is that Parliament’s proposal to require separate E, S and G ratings (rather than a single summary ESG measure) has survived negotiations – reducing the disclosure burden on providers increased. Similarly, the final agreed rules are understood to promote the ‘dual materiality’ approach, which requires explicit disclosure of whether the rating issued addresses both the material financial risk to the rated entity and the material impact of the rated entity on the E, S rating. and G-factors, or whether only one of these factors is taken into account.”
ESG clarity has asked for comments from EFAMA, which is also waiting for the final text to be published before issuing a statement.