The need for regulation arises from concerns about ‘greenwashing,’ where companies may exaggerate or misrepresent their sustainability efforts to attract investment. The new rules require ESG rating providers operating within the European Union to obtain authorization and oversight from the European Securities and Markets Authority (ESMA). Additionally, non-EU-based raters must have their ratings endorsed by an EU-regulated entity.
One key aspect of the regulations is the requirement for raters to explicitly disclose the scope of their assessments, ensuring coverage of a company’s environmental impact, social factors like human rights, and governance practices, rather than solely focusing on financial performance. This move aligns with the EU’s broader sustainability goals, including the concept of ‘double materiality,’ which acknowledges the reciprocal influence of corporate activities on both financial outcomes and environmental/social well-being.
Vincent Van Peteghem, the Belgian Finance Minister, emphasized the potential of transparent and regulated ESG ratings to bolster investor confidence and drive the transition towards a more socially responsible and sustainable future. Aurore Lalucq, a member of the European Parliament, hailed the agreement as a historic breakthrough for sustainable finance, reflecting the collaborative efforts of stakeholders in shaping responsible investment practices.
Under the new rules, ESG raters are required to disaggregate their ratings into environmental, social, and governance components, with explicit weighting assigned to each category. Environmental ratings must indicate whether they consider a company’s alignment with the Paris Agreement’s climate goals, demonstrating a commitment to combatting climate change.
Recognizing the dominance of a few major players in the ESG rating industry, such as MSCI, S&P Global, and Moody’s, the regulations provide smaller EU-based raters with a transitional period of lighter compliance requirements for the first three years. This phased approach aims to foster diversity and competition in the sector, empowering emerging players to establish themselves alongside established giants.
While the agreement represents a significant step forward in promoting responsible investment practices, it is subject to formal approval by EU member states and the European Parliament. Once ratified, the regulations are expected to come into effect by 2025, marking a pivotal moment in the evolution of sustainable finance within the EU.
In contrast to the EU’s regulatory approach, the United Kingdom has proposed a voluntary code of conduct for ESG raters, signaling a different strategy for addressing concerns about greenwashing. This voluntary framework underscores the diversity of approaches towards ESG regulation across different jurisdictions, reflecting the complexity of balancing investor interests with environmental and social imperatives.
