Given the end of the political mandate, the legislative text had to be rapidly finalised and Finance Watch welcomes an agreement that focuses on addressing the most urgent shortcomings. This Regulation is the result of meaningful discussions based on a common sense approach to guarantee corporate practices, transparency and organisational measures that should already be applied by well-governed rating providers.
Remaining issues to address greenwashing risks around ESG ratings
Despite the very positive outcome, Finance Watch still raises specific areas of concern in its overall assessment of the text. In particular, the limited inclusion of financial institutions in the scope of the Regulation may limit the level playing field between traditional rating providers and investment firms distributing ESG ratings in the context of their research services.
As supported by Finance Watch, the ESG Ratings Regulation focuses on ESG rating providers and does not interfere with the rating methodology, leaving the possibility to users of ESG ratings to subscribe to ratings that best fit their needs. This implies that users of ESG ratings also have a responsibility to ensure that ratings will not be used in a misleading way.
Harmonisation with other sustainable finance legislation
Today, many companies are disclosing their own ESG ratings without clearly specifying if they rely on a single or double materiality principle, nor whether they are based on an absolute or a relative assessment. If retail investors and consumers are likely to access claims based on ESG ratings, minimum transparency or quality standards should be specified in the appropriate legislation. Adaptations to the Corporate Sustainability Reporting Directive (CSRD) delegated acts should therefore be considered to require companies to disclose in their sustainability reporting only ESG ratings that would cover the double materiality principle.
ESG ratings may also be used to promote sustainability characteristics of financial products. The inclusion of transparency requirements for asset managers that disclose ESG ratings in product marketing communications was therefore necessary. However, should the Commission confirm the revision of the Sustainable Finance Disclosure Regulation (SFDR) to develop more comparable disclosures at product level, we should question whether the disclosure of ESG ratings at product level should still be permitted.
Currently, SFDR lacks clarity on the definition of key concepts. However, a revision of SFDR should bring more clarity on the concept of sustainable investment and the classification of products. The disclosure of separate ESG ratings based on non-regulated methodologies would only foster confusion. Metaphorically speaking, publishing an ESG rating for a financial product that already includes robust sustainability related disclosure would be like adding an unregulated rating on the performance of a fridge, even though the manufacturer is already required to disclose the standardised and mandatory energy efficiency label.
Let’s not forget ESG data providers
Finally, financial industry stakeholders also share their concerns on the absence of provisions for regulating ESG data providers. Although Finance Watch supports the Commission’s initial approach focusing on ESG ratings – considering timing and priorities – it acknowledges the need to consider better regulating ESG data providers and the development of proxies.
However, the inclusion of ESG data providers would require an important recast of the current text (e.g. defining the concept of ESG data, determining the relevant provisions that should apply to ESG data providers, adapting transparency requirements, appropriately considering requirements for mandatory reporting and public data, etc.) and the development of a separate legislative text may be preferable.
Conclusion
Much still needs to be done on the road towards sustainable finance (read our report: A Finance Watch guide to the next ‘sustainable finance agenda’) but major pieces of the puzzle have successfully been created, such as the ESG Ratings Regulation. The next ‘sustainable finance agenda’ could serve as a springboard towards creating a sustainable economy in the EU but contextual headwinds are threatening this aim. European policymakers must maintain their ambition to preserve the headstart for EU competitiveness in tomorrow’s sustainable market.
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Vincent Vandeloise
