On 6 February 2024, the European Parliament and European Council reached a provisional agreement on a proposal for a regulation on environmental, social and governance (ESG) ratings, with the overarching aim of boosting investor confidence in sustainable products. The objectives of the rules are to introduce a common regulatory approach and enhance the integrity, transparency, responsibility, good governance and independence of ESG rating activities. This relates to the overarching objective of ensuring quality, reliability and comparability of ESG ratings. Under the new rules, ESG rating providers must be authorised by the European Securities and Markets Authority (ESMA) and comply with transparency requirements. These rules sit alongside existing legislation, such as the Sustainable Finance Disclosure Regulation, the Taxonomy Regulation, the Corporate Sustainability Reporting Directive and the Green Bonds Regulation.
Main elements of the provisional ESG agreement are set out below.
Higher transparency through breaking down the ESG rating
As a rule, separate E, S and G ratings shall be provided, as opposed to a single ESG metric which aggregates all three. Where a rating covers the environmental factor, further information on alignment with the Paris Agreement and other relevant international agreements is required. Where a rating covers social and governance factors, information must be given on whether that rating considers any relevant international agreements. This breakdown should allow investors to intentionally target investment into one of the three areas and should clarify the rated entity’s credentials.
Higher transparency through promoting the ‘double materiality’ approach
The rules add further provisions which bolster the double materiality approach. An ESG rating agency should explicitly disclose whether the delivered rating addresses both material financial risk to the rated entity and the material impact of the rated entity on the ESG factors. This also aims to ensure higher transparency.
An ESG rating provider – established in the EU and is categorized as a small undertaking or as a small group- will only be subject to some of the provisions for the first three years of its existence. This has a wider objective of assisting start-up rating agencies and establishing a more diverse ecosystem.
After the deal was struck, Aurore Lalucq (who led the delegation of MEPs) said: “One of the most important achievements of this text is the disaggregation of the Environmental, Social and Governance criteria. Only this can allow investors to be provided with transparent and reliable sustainability information.”
The provisional political agreement is subject to approval by the Council and the European Parliament before going through the formal adoption procedure. The Regulation will start applying 18 months after its entry into force.