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New EU rules for ESG ratings agencies

In a decision on February 6th, 2024, the European Union, uniting its member states and the European Parliament, announced an agreement to establish the first-ever comprehensive regulations for Environmental, Social, and Governance (ESG) rating agencies. This pivotal move aims to bring transparency and accountability to the assessment of companies’ sustainability practices, a critical factor influencing trillions in global investment flows.

Amid growing concerns over ‘greenwashing’—the practice of companies exaggerating their environmental efforts—the new regulations will enforce stricter scrutiny. For the first time, ESG rating providers operating within the EU will be required to obtain official authorization and will be under the supervision of the European Securities and Markets Authority. Additionally, ratings produced by agencies outside the EU will need to be validated by an EU-regulated counterpart to be recognized.

These regulations mandate that rating agencies clearly indicate whether their evaluations consider the impact of a company’s operations on the environment and social issues, such as human rights, beyond merely assessing the financial implications of ESG factors. This is part of a broader initiative to promote “double materiality” encouraging assessments that reflect the mutual influence between businesses and their broader social and environmental contexts. This concept is already a part of EU mandates on sustainability reporting for publicly listed companies.

Vincent Van Peteghem, Belgium’s Finance Minister and a key figure in the negotiations under the current EU presidency, emphasized the role of transparent, regulated ESG ratings in bolstering investor confidence. This, he noted, is essential for steering towards a more sustainable and socially responsible future. Echoing this sentiment, Aurore Lalucq, a French MEP involved in the talks, hailed the agreement as a groundbreaking moment for sustainable finance.

Under the new rules, ESG ratings must separately address environmental, social, and governance issues. In cases where a singular ESG score is provided, the agency must clearly delineate the relative importance of each component, ensuring that social ratings encompass human rights considerations. Environmental ratings are specifically required to reflect a company’s alignment with the Paris Agreement’s goals for reducing carbon emissions.

To foster growth and innovation in the sector, smaller EU-based ESG rating agencies will be subject to a less stringent regulatory framework for the initial three years, addressing the current market dominance by major players such as MSCI, S&P Global, and others.

The formal endorsement of this agreement by EU states and the European Parliament is pending, with the regulations expected to be implemented sometime in 2025. Meanwhile, the United Kingdom is exploring a different path, proposing a voluntary code of conduct for ESG raters as a precursor to potential regulatory measures.

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