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The new legislation follows the issuance of a letter early 2021, by European markets regulator ESMA to the European Commission, advising that the current unregulated status of the ESG ratings sector and the resulting lack of transparency posed a potential risk to investors. In July 2021, the Commission launched a new Sustainable Finance Strategy, which included a pledge to take action to improve the reliability, comparability and transparency of ESG ratings, and subsequently asked ESMA to begin examining the market participants.
In June 2023, the EU Commission unveiled a proposal for ESG ratings providers to be supervised by ESMA, to ensure quality and reliability, with requirements including the use of rigorous and objective methodologies, conflict of interest prevention, and improved transparency into methodologies, models and key rating assumptions.
Under the new rules, ESG ratings providers will be placed under the authority of ESMA, with providers required to be authorized and supervised by the regulator, and to comply with transparency requirements into areas including methodologies used for ratings and sources of information.
The new legislation will also require ESG rating providers established outside of the EU to either obtain an endorsement of their ESG ratings by an EU authorised ESG rating provider or a recognition based on quantitative criteria or to be included in the EU registry of ESG rating providers based on an equivalence decision between the providers’ country of origin’s authorities and ESMA, in order to operate in the EU.
With the adoption of the new rules by Council and Parliament completed, the legislation will proceed to publication in the EU’s Official Journal, entering into force 20 days later, and applying 18 months after entry into force.
The adoption of the new rules follows the release of draft legislation earlier this month by the UK government to regulate ESG ratings providers in the UK.