EU seeks to regulate ESG ratings and will fine agencies that fail to comply

The European Commission proposed this Tuesday to regulate in the European Union the rating agencies that rate companies based on their performance in environmental, social and governance matters to avoid conflicts of interest and fine up to 10% of their annual turnover to those who fail.

Brussels specifically proposes that these agencies have to separate the business of environmental, social and governance (ESG) ratings from other activities with which a conflict of interest may arise, such as consulting services, the issuance of credit ratings, the development of benchmarks, investment activities, auditing, banking, insurance or reinsurance.

In addition, the agencies that offer these services in the EU would have to receive authorization to operate from the Securities and Markets Authority (ESMA), which will also be in charge of supervising their activities.

“This area is now completely unregulated and it is very difficult to compare information between rating agencies and interpret what they mean. We are unclear on how these ratings are arrived at or what they measure and there appear to be conflict of interest issues”, explained the European Commissioner for Financial Services, Mairead McGuinnessin a press conference.

The proposed regulation seeks to make these “ratings” further “transparent, comparable and reliable” and ensure that the qualifications are “independent, objective and quality”.

In recent years, the business of agencies that assess companies based on the environmental and climate impact of their activities has flourished; its social activity, such as the relationship with employees and consumers; or its governance, which includes its management policy or audit and control systems, for example.

The idea behind the evaluation of the ESG criteria is to identify those companies with good practices to guide investors who want to put their money in responsible companies in these areas, but their rapid growth without specific regulation has generated fears that some companies are exaggerating its sustainability credentials and carrying out what is known as “greenwashing”.

To alleviate it, Brussels proposes that the agencies have to publish information on their methodologies, models and assumptions when making the classifications they use for each product or activity and, although it is not committed to harmonizing them, it calls for the methodologies to be “rigorous, systematic, objective and subject to validation” and are reviewed at least once a year.

When ESMA detects that an agency has broken the rules, it may impose a fine of up to 10% of the company’s annual turnover. You can also choose to impose a daily penalty for up to six months equal to 3% of the previous year’s daily billing.

The Commission provides specific rules for smaller providers in order to make them “provided and ESMA may decide to exempt them from certain requirements regarding the organization of the business”.

In 2021, investment funds globally managed US$18.4 trillion in ESG-rated assets and this is expected to rise to US$33.9 trillion by 2026, above the overall market, and the increase in Europe will be 53 % up to US$ 19.6 billion, according to data from the PWC consultancy.

The proposal, which still needs to be negotiated between Member States and the European Parliament and may be amended, is the latest in a broader package of measures on sustainable finance presented today.

This also includes a non-binding recommendation to the countries on how to use the existing rules in the bloc to provide financing for transition activities, that is, those that are not yet sustainable but are on the way to becoming so, as well as delegated acts – rules of direct application – that complete the list of activities “green” of the EU, known as “taxonomy”.

Source: EFE