Will the wild west of ESG ratings soon be history? – New regulation facilitates the assessment of sustainability factors

The relevance of ESG ratings is continuously growing, and the EU now wants to enhance their transparency and reliability. Image: Shutterstock
  • The European Commission has published a proposal for a regulation on ESG ratings. The aim of the regulation is to make it easier for investors, companies and other entities to assess sustainability factors. The proposal also seeks to enhance the transparency and reliability of information about ESG ratings.
  • Finance Finland supports the aims of the Commission’s ESG ratings proposal but considers it important to ensure that its scope of application is purposeful and that it will not introduce any unnecessary barriers for market entry.
  • The proposal is being reviewed by the Parliament and the Council.

ESG ratings make it possible to assess how well companies take ESG factors into account and how their operations affect the environment and society. ESG is short for environmental, social and governance.

As part of its sustainable finance strategy, the European Commission is looking to improve the transparency, reliability and comparability of ESG ratings. This would enable investors, companies and other entities to better assess sustainability factors.

According to Finance Finland’s Legal Adviser Aleksi Kaakinen, the proposal meets a genuine need: until now, ESG ratings have not been regulated at the EU level, let alone nationally.

“The Commission’s proposal seeks to establish regulation that addresses fundamentals such as the authorisation of ESG rating providers, the methodology of the ratings, and the sustainability of the rating providers’ risk management. The Commission does not intend to interfere with the substantive details of the ratings, but slightly more standardised ratings would be easier to compare and supervise”, says Kaakinen.

The devil is in the details

At the time of writing, the Commission’s proposal is being reviewed by the Parliament and the Council. Although the aims of the proposed regulation are clear, many of its details have not yet been resolved. The scope of application, for example, must be specified before the regulation can be approved. The data sources of the ratings and the regulation’s impact on the market and on different-sized entities must also be clarified.

Finance Finland supports the aims of the proposed regulation but considers it important to ensure that its scope of application does not include companies that have no intention to provide ESG ratings as part of their core business. For example, the equity analyses published by financial sector companies should be excluded from the scope of the regulation even if the products involve ESG elements. Finance Finland also thinks it important to ensure that the regulation does not excessively hamper the operation of smaller rating providers and thereby constrict the market. Including raw ESG data in the scope of the regulation should also be reconsidered.

“Although the aims of the proposal are nothing but supportable, it must be prepared very carefully. Finance Finland has issued its own comments on the proposal and continuously interacts with decision-makers and officials in both Finland and the EU.”

The relevance of ESG ratings is growing for businesses and investors alike

A high ESG rating is an important indicator for investors and businesses alike, and its importance is only growing. The components underlying the rating must therefore be as transparent and reliable as possible. The ESG ratings regulation will support the aims of other sustainable finance regulation, such as the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy.

“For a business, a high ESG rating will mean easier access to funding, for example. The rating will also enable the business to benchmark itself against its competitors. For an investor, the ESG rating is a good indicator of how well a company is implementing its responsible investment strategy, and it thus enables the investor to review its portfolio for responsible investees. This, in turn, makes it easier to fulfil obligations arising from the SFDR and reduces risks of greenwashing, for example”, Kaakinen explains.

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