The EU is one step closer to hammering out a regulatory regime for ESG ratings, following confirmation of the European Council’s negotiating position on Wednesday.
The stage is now set for the Council to enter into deliberations with the European Parliament to decide which of the European Commission’s regulatory proposals will make it into EU law. MEPs voted on the parliament’s negotiating mandate earlier this month.
Of the two, the parliament has sought to make significantly more changes to the Commission’s original proposals. These include adding requirements for users of ESG ratings to seek out smaller providers as a way of boosting market competition, and slashing the number of “related businesses” that providers of ESG ratings are prohibited from undertaking under conflict of interest safeguards.
MEPs made an additional amendment requiring providers to split up sustainability scores into their individual E, S and G components. Green finance NGO Reclaim Finance welcomed the revision, describing it as key to prevent “confusing situations where an enterprise with quality governance and good social policies, but a disastrous environmental impact… can make its way into ESG investment portfolios”.
The parliament has also suggested that providers explicitly declare whether a particular rating had taken double materiality into account, and ensure that ESG rating products are benchmarked against relevant international frameworks such as ILO standards, the Paris agreement, and commonly agreed tax evasion and avoidance standards.
In contrast, the EU Council’s final position is mostly in line with the Commission’s proposals and has not departed significantly from an earlier draft seen by Responsible Investor in November.
A point of minor disagreement between the Commission and Council is on conflict-of-interest rules. Like the parliament, the Council has removed requirements for a legal separation between ESG ratings providers and business units that undertake services such as benchmark development, credit ratings and financial, consulting, banking, insurance and investment-related services.
The Council has instead proposed that legal separation only be required for consulting and auditing activities, and even then, only in cases where consulting and audit activities are offered to entities that have been rated by the provider.
ESG rating firms would be allowed to offer multiple related services, aside from consulting and auditing for rated entities, as long as they put in place “specific measures to ensure that the activity is exercised autonomously and avoids creating risks of conflicts of interest within its ESG rating activities”, the Council said in its position statement.
Both the Council and parliament have dropped a Commission draft requirement for ESG ratings to be priced in line with costs incurred by the provider. The proposal had been unpopular with data firms and was slammed by MSCI as “a significant and extraordinary level of intrusion into the determination of fees by the ESG rating providers”.
The Council has confirmed that it will enter into negotiations with the parliament in January, with the process expected to conclude ahead of the 2024 European elections in June.