MEPs ask ESMA to set conflict-of-interest rules for ESG ratings after pushback

Measures to encourage demand for smaller providers have also survived a key parliamentary vote.

A ratings slider showing five lit up stars

The European Commission’s controversial push to enforce a legal separation between ESG ratings providers and “related” business lines seems to be off the table for the time being.

The proposed measure, tabled earlier this year as part of the EU’s forthcoming regulatory regime for the ESG ratings market, had been the centrepiece of the EC’s conflict-of-interest policy.

It would have required ratings providers to spin off business units that offered benchmark development, credit ratings and financial, consulting, banking, insurance and investment-related services.

The measure failed to clear an early legislative hurdle earlier this week, when it was removed from draft legislative text by the influential Economics and Monetary affairs committee (ECON).

The text will form the basis of the European Parliament’s negotiating position when it enters into deliberations with the European Council, which represents the interests of EU member states, to decide which of the Commission’s proposals will make it into the final legislation.

The amended text was later approved by ECON, receiving 33 votes in favour, one against and three abstentions.

According to copies of the text seen by Responsible Investor, EU financial regulator ESMA will be delegated the power to decide “appropriate measures to prevent conflicts of interests… as well as to specify under which conditions ESG rating providers could provide other [related] services”.

ECON has also struck banking, insurance and investment-related services off the list of related businesses, leaving ESG ratings providers free to engage in these activities without applying special safeguards.

RI reported in late November on leaked documents that showed the EU Council was not in favour of separating out related business lines, as long as providers “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”.

The proposal had been unpopular among some of the data firms that would be impacted by it, based on background conversations with more than one provider.

Simmons & Simmons partner and EU regulatory expert Nicholas Colston had separately commented that “forcing ESG ratings providers into a separate legal entity seems like using a sledgehammer to crack a nut, when there are other valid ways of managing conflicts”.

ECON has also dropped requirements for ESG ratings to be priced in line with costs incurred by the provider, another unpopular Commission proposal.

Data firms have been critical of the policy, which the Commission said was intended to keep fees fair and reasonable. MSCI described it as “a significant and extraordinary level of intrusion into the determination of fees by the ESG rating providers”.

The provisions around pricing did not have the support of the EU Council either.

The convergence between the Council and parliamentary positions on conflict-of-interest rules and pricing suggest that the Commission’s proposals in those areas will be dropped from the final legislative text – although they could be revisited at a later date via ESMA.

The regulator will have the overall responsibility to regulate ESG ratings providers and will oversee a mandatory authorisation process for providers operating across the bloc.

Small providers 

ECON has voted to keep measures to support ESG data minnows, in line with earlier deliberations reported by RI. These would require buyers of ratings to “consider appointing at least one ESG rating provider with no more than 15 percent market share in the Union… where an entity or investor seeks an ESG rating from at least two ESG rating providers”.

This is to avoid “higher prices, barriers to entry, lower competition, reduced innovation, less geographical diversity in providers and poor coverage of smaller issuers”, which could result from the dominance of a handful of major supplies in the current market, ECON members said in an explanatory note.

Committee members have, however, revised the market share threshold for eligibility upwards. An earlier draft had proposed a maximum of 5 percent market share for smaller providers that would be beneficiaries of this measure.

ECON had also initially proposed that users should consider a smaller provider if seeking a rating from more than one provider, rather than two providers.

ECON member Billy Kelleher MEP said to RI that there had been an early consensus on the committee that “the Commission’s approach regarding conflict-of-interest requirements had been too heavy-handed and that not all the services listed had the same level of conflict of interest risk”.

“On the issue of cost-based pricing requirements, there was broad agreement that such intervention was not necessary. There has been no evidence of pricing concerns in this nascent market and therefore providers should have the freedom to set their prices and to be competitive with them,” he added.

In its current version, the ECON-approved text will require ratings providers to disaggregate sustainability scores into their separate E, S and G components, address double materiality, and benchmark scores against relevant frameworks such as ILO standards, the Paris agreement and international tax evasion and avoidance standards.

Providers are allowed to calculate ratings that combine E, S and G factors but only if they are equally weighted at 33 percent.

A plenary of EU MEPs will vote to formally adopt the text later this month. It is hoped that negotiations between parliament and Council will start early next year and conclude ahead of the 2024 European elections in June.