08 December 2023

EBF's Quarin: ‘Regulating the ESG Rating Market: The European Banking Sector perspective’

This initiative represents a significant step towards regulating the ESG ratings market, with the primary objective of augmenting integrity, transparency, responsibility, good governance, and independence of ESG rating activities ...

In June 2023, the European Commission (EC) issued a proposal as one of the final components of the Sustainable Finance package, focusing on the transparency and integrity of Environmental, Social, and Governance (ESG) rating activities. This initiative represents a significant step towards regulating the ESG ratings market, with the primary objective of augmenting integrity, transparency, responsibility, good governance, and independence of ESG rating activities and, most importantly, contributing to the transparency and increased quality and comparability of ESG ratings. The proposed Regulation also seeks to establish stringent guidelines for rating agencies’ operations, aiming to mitigate conflicts of interest and biases in the rating process.

The imperative for such regulatory intervention becomes evident in the face of an expanding demand for ESG ratings, exposing inherent issues of unreliability, inaccuracy, and untimely information delivery. The inadequacies of the current ESG ratings market have not only posed challenges for investors and companies but have also eroded confidence in the credibility of these ratings. To address this, there is a pressing need for greater comparability and reliability in ESG ratings, making transparency regarding their characteristics, data sources, and methodologies primary. Furthermore, a crucial aspect to be addressed is the lack of clarity surrounding the operational practices of ESG rating agencies, particularly in relation to conflicts of interest and governance. By establishing a framework that addresses these concerns head-on, the EC aims to foster a healthier and more functional ESG ratings market, conducive to sustainable and responsible investment practices.

The Regulation will apply to ESG ratings issued by ESG ratings providers operating in the EU that are disclosed publicly or that are distributed to regulated financial undertakings in the EU or EU Member States’ public authorities. once the Regulation will have entered into force, rating providers will need to be authorised and supervised by the European Securities and Markets Authority (ESMA). It is important to remark that the Regulation does not seek to harmonize the methodologies used to build ESG ratings, but only to enhance their transparency, allowing users to understand the ratings and compare them. In fact, under this rule, ESG ratings providers would need to comply with certain organisational, record-keeping and disclosure requirements, including in respect of conflicts of interest.  Additionally, the Regulation also addresses the fees charged to clients, to make sure they are fair, reasonable, based on costs and non-discriminatory.

The European Banking Federation (EBF) strongly supports this Proposal, believing transparency to be key in ensuring the comparability and reliability of ESG ratings on the market. In particular, European banks welcome the introduction of disclosures on the websites of ESG rating providers of methodologies, information about rated companies’ fees, data sources, data “timestamps”, as well as of their level of independence. Moreover, they recommend that ESG rating providers operating in the EU are subject to the same requirements, regardless of whether they are based in the EU or not, as to ensure a level playing field among market participants. Banks as well deem important the regulation of ESG data providers whenever ESG data is modified in any manner or sourced from third parties. With data as the foundation of the sustainable finance framework, regulating ESG data providers is fundamental to ensure the overall credibility and functioning of the market. While it may not be most appropriate to address the regulation of data provides within this regulation, which was drafted with ESG Rating Providers in mind, EU banks support the introduction of a review clause for the future regulation of data providers.

 

EBF

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