ESG ratings – draft EU regulation

The European Commission, as part of its work on the sustainable finance package, is working in multiple ways. On the one hand, we have extensive regulation of non-financial disclosures related to the CSRD as a flagship project. On the other hand, a number of other activities dedicated to sustainability in the broader financial sector are underway. One of the regulated issues is ESG ratings – environmental (Environmental), social (Social) and corporate governance (Gouvernance) factors.

What are ESG ratings?

The importance of ESG in the world of sustainable development has been growing in recent years. The topic in the financial sector is a very broad one that includes. risk assessment issues, internal policies and strategies, as well as products offered by banks or investment funds. It also extends beyond the banking world to the corporate level. One of the related elements is ESG ratings. In short, they can be considered an external assessment of the level of sophistication in implementing ESG factors in an organization.

By design, ratings are intended to be unbiased information to assess how sustainable a company or bank is in its operations, both in terms of environmental and social factors and in compliance at the level of policies and procedures. They are supposed to form a basis for comparing different entities with each other. Obtaining a high ESG rating is prestigious, as proof of the “greenness” and pro-sociality of the business. Thus, it is potentially a way to prevent suspicion of the notorious recent greenwashing.

This is what ESG ratings look like in theory. With practice, unfortunately, it is somewhat different. First, there are a lot of companies offering and performing ratings on the market today. Assessments are both paid and free. What’s more, some are performed at the request or order of the assessed entity, with its active participation and on the basis of the materials provided. Others without his knowledge based on publicly available information. As you can easily guess, their quality, reliability and, above all, comparability varies greatly. It is also worth noting that the methodologies for performing ESG ratings, the scope and weights assigned to criteria are very often company secrets. Thus, the reasons for a company’s high or low score cannot be verified.

EC regulations for transparency of ESG ratings

The above problems have been recognized at the European level. Proposals for solving at least some of them can be found in the draft regulation on transparency and integrity of environmental, social and corporate governance (ESG) rating activities. The regulation is intended to ensure not so much comparability as a certain transparency of ESG rating methods in the European Union. The regulations apply to rating providers, including those operating outside the EU. Among the rules proposed in the regulation on ESG ratings are provisions to ensure the independence of assessments, the appropriate level of expertise of staff performing the assessments, how to address conflicts of interest, and provisions on data retention obligations. Supervision of ESG rating providers would be carried out by the European Securities and Markets Authority (ESMA), among others. issuing permits to operate.

The EC’s proposals to regulate ESG ratings will certainly improve the quality of the ratings issued. Ensuring oversight of the activities of ESG rating providers should weed out questionable and unreliable entities. However, there is still a lack of comparability of results and information about the evaluation methods used. These still may be company secrets. This is a big obstacle, especially for ratings without the participation of rated entities.