EU Council Reaches Agreement to Regulate ESG Ratings Providers

The European Council has made a significant stride in the regulation of Environmental, Social, and Governance (ESG) ratings providers, announcing today that it has reached a consensus on a proposal aimed at bringing greater transparency and oversight to this burgeoning sector. The new regulations will place ESG ratings providers under the purview of the European Securities and Markets Authority (ESMA) and implement rules to enhance transparency in their methodologies while mitigating conflicts of interest risks.

In recent years, the ESG ratings sector has experienced exponential growth as investors increasingly prioritize ESG considerations in their decision-making processes. However, the lack of regulatory oversight has raised concerns about transparency and potential risks for investors. ESMA highlighted these issues in early 2021, urging regulatory attention to address the unregulated status of the ESG ratings sector.

The European Commission responded with its Sustainable Finance Strategy in July 2021, committing to enhancing the reliability, comparability, and transparency of ESG ratings. This led to a proposal in June 2023 for ESMA to supervise ESG ratings providers, ensuring adherence to rigorous methodologies, conflict prevention measures, and increased transparency into rating processes.

Under the Council's proposed position, ESG ratings providers operating within the EU will be mandated to obtain authorization from ESMA. Providers established outside the EU can gain approval through equivalence decisions, endorsement of their ESG ratings, or recognition. Importantly, the Council’s stance differs from the Commission's proposal by not mandating separate legal entities for business activities like consulting or credit ratings, provided clear distinctions are maintained, and measures to prevent conflicts of interest are implemented.

A noteworthy aspect of the Council’s position is the inclusion of a temporary optional three-year regime for smaller ESG ratings providers. During this period, these providers will be exempt from supervisory fees and subject to lighter compliance requirements. After the three-year grace period, smaller providers must adhere to all regulatory provisions, including supervisory fees.

This agreement forms the basis for negotiations between the European Parliament and the Council on the European Commission's proposal. The anticipated discussions, set to commence in early 2024, mark a crucial step toward establishing a comprehensive regulatory framework for ESG ratings providers within the European Union.

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