The European Union (EU) has reached a landmark agreement on the regulation of ESG (Environmental, Social, and Governance) ratings, marking the bloc’s inaugural step towards governing the assessment of corporate sustainability practices. This decision, aimed at combating the prevalent issue of ‘greenwashing’, mandates ESG rating agencies within the EU to secure authorization and operate under the oversight of the European Securities and Markets Authority. Agencies outside the EU are required to have their ratings officially endorsed by an EU-regulated counterpart.
The new regulations stipulate that rating agencies must transparently reveal whether their assessments evaluate the influence of a company’s activities on environmental and social aspects, such as human rights, alongside the impact of ESG factors on the company’s financial performance. This initiative promotes the concept of “double materiality,” ensuring that ratings reflect the mutual influence between a corporation and its environmental and societal context. The concept is already a standard in the EU’s sustainability reporting for listed companies.
Vincent Van Peteghem, Belgium’s Finance Minister, underlined the significance of this development, stating, “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.” Aurore Lalucq, a member of the European Parliament involved in the negotiations, echoed this sentiment, describing the agreement as “a historic breakthrough for sustainable finance.”
In a detailed move, the new framework necessitates that ratings distinctly categorize environmental, social, and governance factors. For combined ESG ratings, clear distinctions must be made in the weightings of each component, ensuring that social ratings encompass elements like human rights. Additionally, environmental ratings must explicitly state whether they align with the Paris Agreement’s objectives for carbon emission reduction.
To foster industry diversity and growth, smaller EU-based rating agencies will initially adhere to a lighter set of regulations for the first three years, offering them an opportunity to expand in a market currently led by major entities like MSCI, S&P Global, London Stock Exchange Group, Moody’s, and Morningstar’s Sustainalytics.
While the EU is moving towards formal ratification and implementation of these rules, expected to be enforced around 2025, Britain is charting a different course. The UK has proposed a voluntary code of conduct for ESG raters as a precursor to potential regulatory measures.
