EU Council poised for ESG Rating Regulation

In a landmark move, the European Union (EU) is advancing efforts to fortify investor confidence in sustainable products through a comprehensive set of rules targeted at enhancing the reliability of Environmental, Social, and Governance (ESG) ratings. These ratings play a pivotal role in evaluating a company’s sustainability profile and are poised for a significant transformation under the latest agreement reached by the EU Council.

Key highlights of the Council’s agreement signify a substantial regulatory shift in the ESG rating landscape. The agreement mandates that ESG rating providers undergo authorisation and supervision by the European Securities and Markets Authority (ESMA), introducing a new layer of transparency, especially concerning their methodologies and information sources. Additionally, these providers will be subject to measures aimed at preventing and managing conflicts of interest.

The Council’s agreement introduces notable modifications to the initial proposal. Most significantly, the regulation’s scope now includes detailed exemptions and aligns with the corporate sustainable reporting directive, encompassing a broader array of factors such as human rights. Compliance with specific requirements, including ESMA authorisation for ESG rating providers operating within the EU or an equivalence decision, endorsement, or recognition for non-EU entities, becomes mandatory.

In a move to support smaller market players, the Council has introduced an optional registration regime for small ESG rating providers. This lighter regime, valid for three years, exempts participants from certain fees and allows adherence to general organisational and governance principles without the full weight of compliance.

A critical aspect of the agreement addresses the separation of business activities. ESG rating providers are now permitted by the Council to forego the establishment of separate legal entities for certain activities, provided they ensure clear distinctions and implement measures to prevent conflicts of interest, especially in consulting or audit activities.

The confluence of the European Parliament’s agreement on its negotiating mandate and the Council’s stance paves the way for interinstitutional negotiations scheduled to commence in January 2024. This development represents a pivotal moment in the EU’s commitment to sustainable finance, potentially reshaping the landscape of ESG ratings and sustainable investing.