ESG rating activities

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The European Parliament and the Council reached a provisional agreement on 5 February 2024 on a proposal for a regulation on environmental, social and governance (ESG) rating activities. The new rules are intended to strengthen the reliability and comparability of ESG ratings and boost investor confidence in sustainable products. How are ESG ratings used? And what will the regulation change?

ESG ratings in a nutshell

ESG ratings are a form of assessment generally carried out by specialised companies known as ESG rating providers and taking the form of a score – or an opinion – on a company’s or a financial instrument’s sustainability profile. There are many different types of ESG ratings, but the most common are those that measure a company’s exposure to sustainability risks, or its impact on the environment and society in general. They are based on an established methodology and follow a defined ranking system, for example ranking a company from A to H or 1 to 5.

What are ESG ratings useful for?

ESG ratings have an important impact on the operation of capital markets and on investor confidence in sustainable products. They provide a critical source of information for investment strategies, risk management and disclosure obligations, not only for investors but also financial institutions. Companies also use them to better understand the sustainability risks and opportunities linked to their own activities or those of their partners, and to compare themselves to other, similar companies. The use of ESG ratings is expected to grow substantially in the coming years.

What are the main issues?

In the first sustainable finance action plan, in 2018, the EU put in place the building blocks for a more sustainable economy, for example with the EU taxonomy and the Sustainable Finance Disclosure Regulation. Up until this point, the market of ESG ratings was not subject to any rules at all, be it on transparency or organisational requirements. The Commission conducted a study, as well as several outreach and public consultations. These identified a number of issues related to the functioning of the ESG ratings market, in particular regarding transparency and the integrity of ESG rating activities.

The 5 February agreement by Parliament and the Council followed a proposal for a regulation on the transparency and integrity of ESG rating activities, put forward by the Commission on 13 June 2023. This framework sets out the need for ESG rating providers to be authorised and subject to supervision by the European Securities and Markets Authority (ESMA) in order to offer their services in the EU.

What will the regulation change?

The framework lays down a number of organisational requirements for ESG rating providers, in order to prevent and mitigate conflicts of interest. ESG rating providers should establish appropriate internal policies and procedures in relation to employees and other individuals involved in the rating process. The regulation also lays down that ESG ratings cannot be offered together with other consulting, audit, credit rating or benchmark services.

In parallel to these rules on organisational requirements, the regulation provides for extensive transparency and disclosure requirements. These are intended to ensure that users of ESG ratings and other interested parties understand these ratings and how they work.

The aim of the regulation is not to harmonise the methodologies for the creation of ESG ratings, but to increase their transparency. ESG rating providers will maintain full control of the methodologies they use and will remain independent when it comes to the choice of those methodologies. This will ensure that a variety of approaches are available in the ESG ratings market.

A number of major players offering ESG ratings in the EU are located outside the EU. Therefore, the regulation also sets out avenues for those non-EU country providers to offer their services in the EU.

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ESG rating activities

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