On 20 December, the European Council announced that they have reached an agreement on a proposal to regulate ESG ratings providers, bringing the providers under the authorization of European markets regulator ESMA, with new rules to increase transparency into the methodologies and models used by the providers, and to address the risk of conflicts of interest.
In early 2021, ESMA sent a letter to Mairead McGuinness, the European Commission’s financial services coordinator, expressing concerns about the unregulated status of the ESG ratings sector, which posed a potential risk to investors due to a lack of transparency. In response, the Commission launched a new Finance Strategy in July 2021, committing to enhance the reliability, comparability, and transparency of ESG ratings. ESMA was subsequently tasked with examining market participants.
In June 2023, the EU Commission proposed that ESMA supervise ESG ratings providers to ensure quality and reliability. The requirements included the use of rigorous methodologies, prevention of conflicts of interest, and increased transparency into methodologies, models, and key rating assumptions.
The Council’s proposed position, which will guide negotiations with the EU Parliament, mandates that EU-based ESG ratings providers obtain authorization from ESMA, while those outside the EU must receive an equivalence decision, an endorsement of their ESG ratings, or recognition. Unlike the Commission’s proposal, the Council’s position does not necessitate separate legal entities for business activities, as long as providers establish a clear distinction and implement measures to avoid conflicts of interest.
Additionally, the Council introduces a temporary optional three-year regime for smaller ESG ratings providers, exempting them from supervisory fees and imposing lighter compliance requirements. After the initial period, these providers must comply with all regulations, including paying supervisory fees.
Negotiations on the new regulation between the EU Parliament and Council are anticipated to commence in early 2024.
