Policy brief – Regulating ESG ratings to strengthen sustainable investors

17 May 2023

Policy brief

In a policy brief published on May 17, Finance Watch proposes concrete policy measures to make ESG ratings reliable and meet the needs of ESG investors and other stakeholders, including regulators, while also supporting the EU’s transition to a sustainable economy.

ESG ratings today are opaque and hard to compare.

  • Under-resourced rating providers are measuring E, S and G in one rating using different methodologies.
  • Most rating agencies focus on the relative ESG performance of a company, not the absolute.
  • ESG rating providers usually assess the “financial materiality” (how sustainability considerations affect businesses), when consumers think “impact materiality” (how business activities impact communities and the environment).

This has contributed to friction and misunderstandings between civil society and retail investors on one side, and professional investors and corporates on the other.

The upcoming legislative proposal on corporate ESG ratings expected from the European Commission on 13 June is a key opportunity to strengthen supervision to end the confusion.

In this policy brief, Finance Watch has put forward five recommendations for EU policymakers:

  1. Oblige ESG ratings agencies to provide individual, standalone sustainability ratings for environmental, social and governance factors. For each, it should be clear what is being assessed – financial returns or real-world impact.
  2. Link environmental assessments to the EU taxonomy and highlight any significant divergences. Environmental assessments are not required to align with the EU taxonomy of sustainable economic activities, but any differences must be clearly explained to ensure a basic level of consistency. For example, if a company is 2 percent aligned with the EU taxonomy but has been granted an E status by an ESG rating provider, why and how this difference has occurred must be communicated.
  3. Make ESG rating more transparent. It should be mandatory for ESG ratings providers to publicly disclose their methodologies, material objectives and whether ratings are absolute or relative. Rating agencies should also make it clear which data sources are being used and whether or not this data has been audited.
  4. Prevent conflicts of interest. ESG rating providers should be banned from selling consultancy services to companies they are rating and from rating their own shareholders. To ensure independence, no legal or natural person should hold a participation over 5% in more than one ESG rating provider. ESG rating providers must also put in place internal controls and processes to prevent and control possible conflicts of interests.
  5. Increase supervision. The provision of ESG ratings in the EU and their use by investors should be overseen by the European Securities and Markets Authority (ESMA), the EU Authority in charge of regulating and supervising financial markets.

Read the policy brief