Europe’s investment industry has welcomed a proposed regulation for ESG rating providers as a crucial step toward preventing conflicts of interest in ESG reporting. The proposed regulation is in line with a provisional agreement between member states and the European Union parliament that was struck in early February.
They would require ESG ratings providers to provide separate ratings for the three ESG pillars: environmental, social and governance. Alternatively, ESG rating providers that opt for an aggregate ESG rating could also explain how they weighted the three ESG pillars.
According to the European Fund and Asset Management Association (“EFAMA”), “much clearer mandatory disclosures” are welcome news. EFAMA regulatory policy advisor, Chiara Chiodo, said transparent and complete environmental, social and governance information will be key to providing investors with the information they need to make confident and informed decisions when they choose financial products equipped with sustainability features.
Chiodo noted that including ESG ratings in the proposed regulations was a necessary step toward transitioning to a cleaner economy.
ESG refers to a set of considerations or standards that socially conscious investors use to guide their investment strategies. Companies also use ESG as a framework for assessing their practice and performance on various ethical and sustainability issues, providing them a means of measuring the business opportunities and risks in these areas.
The proposed EU regulations will allow for more transparent and accurate ESG reporting. Dutch pension funds PMT and PME welcomed the proposed regulations and said they expect them to increase the quality of ESG ratings. According to a spokesman from the tech industry PME, current ratings often provide an unclear or muddy picture as possible compensation between the three ESG pillars varies over quite a wide range.
A PMT spokesperson noted that the different methodologies and approaches practiced by ESG rating providers can result in major discrepancies in ESG ratings. Consequently, the spokesperson says the metals pension scheme often has to interpret different results before using them to inform their investment decisions.
North Rose Fulbright lawyer Nikolar de Konig says that requiring the European Security Markets Authority (“ESMA”) to supervise credit rating agencies will encourage the convergence of different ESG ratings. ESMA supervision will force ESG rating agencies to provide better explanations of the reasoning behind their ESG scores, he says.
The proposed regulations would also require that ESG rating providers separate the rating business from their other commercial services, a rule that will affect large agencies such as Moody’s, Fitch and MSCI, which offer ESG ratings alongside other credit benchmarks.
Many American companies would likely welcome similar guidelines in North America so that all corporations are assessed based on the same ESG standards.
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