New rules for ESG rating providers - Proposal Regulation of the European Parliament and of the Council on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities

As part of the European Commission’s Strategy for Financing the Transition to a Sustainable Economy (published in July 2021) and following the call for evidence carried out last year, as well as subsequent discussions and consultations with the relevant stakeholders, the European Commission adopted the Proposal Regulation of the European Parliament and of the Council on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities (Proposal Regulation).  

Broadly, the Proposal Regulation (i) applies only in those cases when the ESG ratings are disclosed to the public or are distributed to regulated financial undertakings in the EU and (ii) aims to establish:

1. the authorization requirements for ESG rating providers established within the European Union;
2. the conditions in which the ESG rating providers established in a third country may provide and ESG rating with the European Union.¹

The Proposal Regulation does not establish methodologies for determining ESG ratings, but rather intends to increase transparency and to prevent greenwashing in this area. To achieve these goals, the Proposal Regulation sets-out the conditions for authorization and supervision by the European Securities and Markets Authorities (ESMA), as well as rules to be applied by an ESG rating provider from a governance perspective.

As part of the authorization process, the legal entity envisaging carrying out activities as an ESG rating provider should make available to ESMA, inter alia the identity of its senior management, their level of qualification and experience, a description of the procedures, procedures and methodologies that shall be used by the company to issue and review ESG ratings, as well as the policies and procedures to identify and disclose any conflict of interest.

Further to the authorisation, the ESG rating provider must follow certain independence criteria and not carry out inter alia any activities regarding consulting services to investors and undertakings, issuance of credit ratings, investment activities, audit activities.

From an organizational perspective, the ESG rating provider is required to put in place a clear organizational structure, with well-defined roles and responsibilities for the people involved in granting and ESG rating (e.g. these people need to have appropriate knowledge to carry out their task and their compensation and evaluation should not create any conflict of interests; the employees, analysts and other persons involved in granting ESG ratings shall not be involved in negotiating any fees or payments with the rated entity).

In carrying out its activity, the ESG rating provider should implement methodologies that are rigorous, objective, systematic and capable of validation and these should be reviewed at least once per year.

The Proposal Regulation is under public consultation and feedback may be submitted by 1 September 2023, which shall be then presented to the European Parliament and the Council.

If adopted, the Proposal Regulation shall enter into force on the twentieth day since it is published with the Official Journal of the European Union and shall be applicable in six months from its entry into force.

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¹ For an overview of the Proposal Regulation, please check the LawNow prepared by CMS Luxembourg available at Introduction of an EU regulatory framework for ESG rating agencies