man shoving spanner in cogs

The Spanish presidency of the Council of the EU is set to propose ditching requirements for ESG ratings providers to be separate legal entities from other business interests under upcoming regulation.

A copy of the presidency compromise text seen by Responsible Investor proposes that ratings providers may provide consulting, audit, credit ratings and benchmark development services within the same entity “when they put in place specific measures to ensure that each activity is exercised autonomously and avoids creating risks of conflicts of interest within its ESG rating activities”.

However, this would not be applicable if consulting and audit activities are offered to rated entities. In that case, legal separations would have to be in place.

A note on the position says the Council will reflect on whether this should be narrowed down to ESG-related auditing and consulting.

The original proposal from the European Commission called for complete legal separation between ratings providers and other related business interests. It caused some confusion in the market, with one lawyer describing it as “using a sledgehammer to crack a nut”.

Among the other proposed changes is dropping the requirement for ESG ratings to be provided “based on cost”. The proposal received significant pushback from providers, who argued that the requirement went beyond normal regulatory requirements and had not been subject to wider consultation.

Firms will still be required to ensure fees are fair, reasonable, transparent and non-discriminatory, and a new proposal has been added requiring annual disclosure to ESMA on pricing policies.

The proposed text will be discussed in the Council Working Party on Wednesday. Speaking on condition of anonymity, an EU source told Responsible Investor that the presidency aims for the Council to agree on the proposal in December, ahead of negotiations with the European Parliament early next year.

Competition concerns

A document seen by RI outlining a separate Dutch proposal on competitive disadvantages for new entrants in the EU reveals anxieties about US and UK dominance of the ESG ratings market.

The paper notes that all the major ratings providers apart from ISS are headquartered in the UK or US, and that “new entrants from within the EU face a significant competitive disadvantage from US and UK ESG rating providers”.

While the paper supports the Commission’s effort to develop a proportionate regime, it argues that its proposal “doesn’t sufficiently address the problem for new entrants”. Under the current proposals, companies in the EU would have to comply with the regime from the outset, but non-EU firms would be subject to a more lax code of conduct or no regime at all.

The proposed Dutch solution, an amended version of which was subsequently included in the Presidency compromise text for further discussion, is to exempt providers with a consolidated turnover on all their activities of less than €3 million.

Firms which exceed this threshold or which have been registered for five years will become subject to the regulation. There is also an option to opt in before then.

Tweaks and alterations

Other changes suggested by the presidency include the explicit addition of a series of metrics to the regulation. This would cover taxonomy alignment and SFDR principal adverse impact solutions, as well as implied temperature rise metrics.

There is also an explicit exclusion of the European Single Access Point, two proposed tweaks to the definitions of ESG data to be excluded, and a proposal to bring ratings paid for by the issuer in scope.

Also new in the presidency’s position is an extension to the timelines for implementation. The regulation would apply 24 months after coming into force rather than six to extend the adaptation period, and providers would have 12 months to apply for authorisation.

When evaluating applications, ESMA would have to respond in a shorter period of time, and provide a rationale for rejections. Rated entities would also have to be given at least one working day to correct factual errors in a rating, in line with credit rating regulations.