EU Agreement on ESG Ratings Seen as World’s Toughest

A provisional agreement in the European Union setting guardrails around the ESG [environmental, social, and governance] ratings industry is being hailed as the world’s toughest.

The plan goes “much further than any of the other regimes we have seen internationally,” Raza Naeem, financial regulation partner at Linklaters, said in a statement on Tuesday. Naeem pointed to the “very broad scope” of the proposed rules, “which could capture ESG products that don’t fall within the traditional notion of ESG ratings,” as well as a plan to have ratings providers that are covered by the proposal to “hive off and segregate certain conflicting business activities.”

Linklaters said a key takeaway was also that “the final agreed rules promote the ‘double materiality’ approach, thereby requiring explicit public disclosure of whether the delivered rating addresses both material financial risk to the rated entity and the material impact of the rated entity on the E, S and G factors, or whether it takes into account only one of these.”

What’s more, raters will likely need to provide separate scores for an entity’s environmental, social and governance profile, instead of lumping all three factors into a single score. If raters provide a single figure, they’ll have to be explicit about how they weight E, S and G, according to a European Council statement.

Under the agreement, ESG ratings providers based in the EU “will need to obtain an authorization” from the European Securities and Markets Authority, the Council said. “ESG rating providers established outside the EU that wish to operate in the EU will need to obtain an endorsement of their ESG ratings by an EU authorized ESG rating provider,” it said.

The provisional agreement reached by the European Council and the European Parliament on regulating environmental, social and governance rating activities is intended to boost investor confidence in sustainable financial products, the Belgian Presidency of the Council of the European Union said in a post on X.

Under the agreement, ESMA could decide to exempt small ESG ratings providers from some of the requirements, “but only in duly justified cases and based on the nature, scale and complexity of the business of the ESG rating provider and the nature and range of the issuance of ESG ratings,” the Council said.