EU regulation on ESG ratings

The PRI welcomes the European Commission’s proposal to regulate ESG ratings and the providers of these products and to make these entities subject to authorisation and supervision by ESMA. The proposed rules will increase transparency on the methodologies of ESG ratings, enabling investors to better compare and understand these products. The proposed governance requirements will help to ensure ESG ratings are independent and devoid of conflicts of interest, which will foster trust and confidence in this growing market.

This paper aims to outline policy recommendations to improve the draft regulation and ensure greater reliability and integrity for investors, during trilogues starting in January 2024. It focuses on four key issues: scope of the regulation for data product providers and non-profit civil society; transparency requirements and conflict of interest. While the treatment of third-country providers and especially the regime for them to be allowed to offer ESG ratings in the EU will also be a sticking point for trilogues, PRI does not have specific position on that issue.

Over the past few years, the growth of responsible investment practices has led to a steep increase in demand for ESG information. Many investors rely on corporate reporting, complemented by ESG data and ratings products, to assess portfolio performance and inform voting decisions and engagement practices.

The PRI notes that ESG ratings products based on clear objectives, transparent methodologies and reliable ESG data can enable investors to make better informed decisions and incentivise sustainable investments. However, it is PRI’s view that the transparency and integrity of the ESG ratings products market should be improved. PRI has engaged on this topic by responding to consultations from IOSCO (September 2021) and the European Commission (June 2022), and commenting on the EU sustainable finance package published in June 2023. In our various communications, we reiterated the need to:

• Improve transparency of both ESG data and ratings product providers on their methodologies and data processes, by developing minimum quality and transparency standards.
• Ensure that ESG data and ratings product providers have appropriate governance arrangements in place that prevent conflicts of interest and ensure the independence and integrity of their research and offering.

In this respect, the PRI welcomes the European Commission’s proposal to regulate ESG ratings and the providers of these products which goes in the right direction to increase transparency and integrity in the ESG ratings market. The proposal has already been welcomed by important market players such as Future of Sustainable Data Alliance (FoSDA)1. The PRI also welcomes the Parliament’s final position2 on the file and its willingness to clarify transparency requirements and strengthen the conflict-of-interest provisions. PRI also welcomes the Council’s General Approach3 which clarifies the scope of the regulation for EU and non-EU providers of ESG ratings.

With trilogues planned to start in early January 2024, the PRI would like to share some recommendations to improve the draft regulation and ensure greater reliability and integrity for investors. This includes broadening the scope of the regulation to include ESG data product providers, ensuring that transparency requirements lead to comparable and more generally decision-useful data for investors4, and tackling conflicts of interest more effectively.

The PRI’s position on this file seeks to find a balance between the user perspective (investors) – who rely on both ESG ratings and data providers for their investment decisions and reporting activities– as well as the ESG information provider perspective, still seen as a relatively nascent industry, in the process of adapting its business model and products to evolving corporate disclosure obligations under the Corporate Sustainability Reporting Directive (CSRD) (and accompanying European Sustainability Reporting Standards - ESRS ) and the Taxonomy regulation.

Therefore, in addition to our recommendations on ESG ratings, the PRI recommends accelerating the reforms towards mandating corporate reporting standards and disclosures of key underlying ESG data. These efforts are crucial to increase the availability and quality of ESG data, and by extension the quality of ESG ratings and data products, as both investors and providers need decision-useful corporate disclosure. We welcome extensive efforts by the European Commission and EFRAG in finalising the first set of ESRS – which will greatly improve the decision-usefulness of corporate ESG disclosures across many sustainability issues, while ensuring interoperability with international standards. Although largely limited to EU-based issuers, we see these developments as complementary and additional to the goal and scope of the ESG ratings regulation to improve the functioning of the ESG information market.