What the EU is doing and why?
Ratings on environmental, social and governance (ESG) factors provide information about the sustainability performance of a company or a financial instrument, by assessing its exposure to sustainability risks and/or its impact on people and the environment. There are different terms used by ESG ratings providers like ratings, scores, valuations, opinions, etc.
There are different type of ESG ratings/scores
- aggregated ratings of E, S and G factors, ratings of individual factors (e.g. environmental) or ratings of subfactors (e.g. climate risks)
- ratings using double materiality perspective (assessing risk and impacts) or single materiality perspective (assessing only risks, or only impacts) or using international frameworks/standards (e.g. SDGs)
- ratings involving the rating analysts or scores based purely on data analysis
ESG ratings are mainly developed and distributed by specialised ESG rating providers, however, some financial institutions also develop own ESG ratings.
ESG rating play an increasingly important role for investors and for fostering confidence in sustainable investments. Investors increasingly use it as part of their sustainable investment strategies to take into account risks and/or impacts linked to ESG issues. As for companies, they use it to look for and take account of operational risks and investment opportunities but also to see how they perform against ESG factors, compared to peers.
The EU agreed a new regulation on ESG rating activities that will ensure that investors and other stakeholders have access to reliable and comparable information about the ESG ratings objectives (what they assess) and methodologies (how they assess). Given the importance of ESG ratings in investment decisions, this in turn will contribute to enhancing the culture of transparency about the impact of companies on people and the environment. This will reduce greenwashing and promote sustainable investments.
More in detail, the new rules will make ESG ratings and their underlying methodologies more transparent and strengthen the governance of ESG rating providers as well as their independence. The ESG Ratings Regulation introduces also amendments to Sustainable Finance Disclosure Regulation (SFDR), in order to ensure that if financial undertakings develop and disclose their own ESG ratings they disclose the same information as specialised ESG rating providers. Furthermore, the regulation requires that ESG rating providers offering services to investors and companies in the EU are authorised and supervised by the European Securities and Markets Authority (ESMA). They will also help provide more clarity over the operations of ESG rating providers, in particular their prevention and mitigation of conflicts of interests.