Following their fourth trilogue meeting, the Council and Parliament announced on 5 February 2024 provisional agreement has now been reached on the Commission’s ESG Ratings Regulation proposals.
The EU developments today mark another important milestone in the international supervision and regulation of ESG ratings providers - and we are also seeing voluntary codes or regulatory regimes emerging in leading financial jurisdictions such as Japan, Singapore and the UK. The EU proposals however go much further than any of those other regimes we have seen - given the very broad scope proposed for "ESG ratings" (which could capture ESG products that don't fall within the traditional notion of ESG ratings) and proposals that would require in-scope ratings providers to hive off and segregate certain conflicting business activities (although some useful exemptions have been introduced to limit the impact of the segregation rules). Non-EU ESG ratings providers will also be subject to these rules and will have to meet certain requirements in order to provide their ratings in the EU (endorsement by an authorised EU ESG ratings provider, recognition or equivalence by ESMA or set-up an EU authorised ESG ratings provider). Overall the announcement from today represents a significant development for not just providers of ESG ratings within the EU but also their users, who in some cases (e.g., if subject to SFDR) will need to provide disclosures of ESG ratings used and/or will indirectly benefit from the increased regulation of their ESG ratings providers.
The final text is yet to be published, so what do we know about what has been agreed?
The devil is in the detail, so stakeholders will need to wait to see the final text to understand what has been agreed on the more controversial elements of the trilogue discussions. This includes:
- the final word on what falls within the scope of the “ESG Ratings” definition
- whether the original Commission proposal that there should be no interference with the content of ESG ratings or methodologies has survived;
- whether the Parliament has succeeded in including conditions around the use of multiple ESG ratings providers;
- what turnover threshold has been set for 3rd country ratings providers; and
- the extent to which in-house ratings attached to financial products will be caught by the final rules.
What we do know is that the Parliament’s proposal requiring separate E, S and G ratings to be provided (rather than a single aggregating ESG metric) has been included in the final agreement – thus increasing the disclosure burden on providers (the aim here is to enable investors to better target their investment into one of the three areas, and have a clearer idea of the rated entity's credentials). In addition, the agreed rules add provisions to ensure that the rating agency should explicitly disclose whether the delivered rating assesses how the rated entity affects and is affected by E, S and G factors, i.e. whether the delivered rating addresses both material financial risk to the rated entity and the material impact of the rated entity on the environment, social and governance factors, or whether it takes into account only one of these. “In this way, ESG raters are encouraged to address the material impact of the rated entity on the environment and society (double materiality) more than is currently the case.”
Small undertakings and groups providing ESG ratings will no doubt be happy to see that the Council’s proposal for a lighter touch temporary and optional registration regime has survived the negotiations – albeit such providers will upon exiting the temporary regime be subject to the full regime (at latest 3 years from the date they enter the regime).
The provisional agreement reached on 5th February still needs to be endorsed and formally adopted by both the Parliament and the Council before being published in the Official Journal and entering into force 20 days later.
UPDATED 21/02/2024: The final ESG Ratings Regulation political agreement was published on 15/02/2024. You can find our detailed client note on the final rules here and the text of the final political agreement here.