EU Council and Parliament Reach Agreement on ESG Rating Regulation

The European Council and Parliament have reached a provisional agreement on a groundbreaking proposal for a regulation governing environmental, social, and governance (ESG) rating activities. This regulatory initiative aims to bolster investor confidence in sustainable products, recognizing the crucial role ESG ratings play in shaping capital markets and fostering trust in sustainable investments.

Vincent Van Peteghem, Belgian Minister of Finance, expressed his support for the agreement, highlighting the potential impact on our collective journey towards a more socially responsible and sustainable future. He emphasized the need for transparent and regulated ESG ratings to instill confidence among investors.

The proposed rules are designed to fortify the reliability and comparability of ESG ratings by addressing transparency and integrity concerns within the operations of ESG ratings providers. Key aspects of the provisional agreement include:

1. ESMA Authorization and Supervision: ESG rating providers will be required to obtain authorization and supervision from the European Securities and Markets Authority (ESMA). They must adhere to stringent transparency requirements, particularly concerning methodologies and information sources.
2. Clear Scope and Exclusions: The Council and Parliament have provided detailed clarification on the circumstances under which ESG ratings fall under the regulatory scope, including specific exclusions. The territorial scope has also been outlined, defining what constitutes operating within the EU.
3. Transparency in Marketing Communications: Financial market participants and advisers disclosing ESG ratings in marketing communications will be obligated to include detailed information about the methodologies used on their websites. This amendment is incorporated into the Sustainable Finance Disclosure Regulation.
4. Comprehensive E, S, and G Factors: The agreement affirms that ESG ratings encompass environmental, social, and human rights or governance factors. While the possibility of providing separate ratings for each factor is acknowledged, if a single rating is provided, the weighting of each element must be explicit.
5. EU Authorization and Recognition for Non-EU Providers: ESG rating providers based in the EU need authorization from ESMA, while those outside the EU seeking to operate within the region must obtain endorsement from an EU-authorized provider, recognition based on a quantitative criterion, or inclusion in the EU registry.
6. Temporary Registration Regime for Small Providers: The Council and Parliament have introduced a temporary, optional registration regime lasting three years for small ESG rating providers. Those opting in will benefit from supervisory fees proportionate to the extent of ESMA supervision. They must comply with organizational and governance principles, transparency requirements, and ESMA's powers during this period.
7. Exemptions for Small Providers: The agreement grants ESMA the authority to exempt small ESG rating providers from certain requirements under justified circumstances, based on the nature, scale, and complexity of their business.
8. Separation of Business and Activities: The agreement introduces a principle of separating business and activities for ESG rating providers. While the possibility of not setting up a separate legal entity is acknowledged, this derogation does not apply to providers engaged in consulting, audit, and credit rating activities. However, ESG rating providers may develop benchmarks if deemed appropriate by ESMA to address conflicts of interest.

This historic provisional agreement will now undergo approval by the Council and Parliament before progressing through the formal adoption procedure. The regulation is anticipated to come into force 18 months after its entry into force, marking a significant step toward a more transparent and accountable framework for ESG ratings in the European Union.

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