On 4 April 2022, the European Commission published a call for evidence on the functioning of ESG ratings and sustainability risks in credit ratings. The aim of the initiative is to help the Commission to gain a better insight on the functioning of the market for ESG ratings, as well as better understand how Credit Rating Agencies (CRAs) incorporate ESG risks in their creditworthiness assessment.
The initiative is part of the EU strategy for financing the transition to a sustainable economy and follows growing global concerns over a lack of transparency and potential conflicts of interest within the ESG Ratings Markets (see here and here.)
The Commission is keen to strengthen the reliability and comparability of ESG ratings and is exploring the use of non-binding guidelines as well as potential new legislation on the operations of ESG rating providers. Such legislation could potentially set rules for the authorisation of ESG rating providers, their operations and transparency of their methodologies, rules on conflicts of interests and separation of departments, a sanctioning regime, and a supervisory regime at EU level.
The Commission is also examining how ESG risks are captured in credit ratings and will explore the use of additional supervisory powers and revised guidelines - for example, ESMA could revise guidelines applicable to credit ratings to make disclosure more granular, or the CRA Regulation could be amended to clarify the rules on disclosure and requirements regarding the integration of ESG factors in credit ratings.
On the same day, the Commission also published a targeted consultation on the functioning of the ESG ratings market. The consultation is an integral part of the renewed EU sustainable finance strategy adopted in July 2021 and has been complemented by ESMA's call for evidence on ESG ratings (see our earlier blog post).
The first part of the consultation aims to inform the Commission on the dynamics relating to the ESG ratings market, and on the interplay between larger and smaller market players. The second part of the consultation aims to identify possible shortcomings in the consideration of sustainability risks in credit ratings and the disclosures made by CRAs. The consultation also seeks views on the use of other types of tools that can be offered by sustainability-related providers, including research, controversy alerts, rankings, etc.
The call for evidence and consultation both close on 6 June 2022.
The responses to the consultation and call for evidence will feed into an impact assessment that the Commission will prepare in 2022, with a view to possibly proposing legislative or non-legislative initiatives in Q1 2023.
What are ESG ratings and credit ratings?
Both credit ratings and ESG ratings are opinions provided by specialised entities and used by financial institutions and professional investors. The term ESG ratings refers to a wide and heterogeneous group. There is no single definition of ESG ratings although it can be said that ESG ratings generally assess the impact of ESG factors on a company and/or a company's impact on the outside world. Credit ratings to the contrary are precisely defined and they assess the creditworthiness of companies or financial instruments by providing an opinion on one type of financial risk, namely the risk of default of a company.