The European Commission has introduced a set of rules focused on regulating providers of environmental, social, and governance (ESG) ratings in an effort to improve the reliability, transparency, and comparability of these ratings. The new ESG Ratings Regulation aims to scrutinize ratings provider methodologies and vet providers for potential conflicts of interest, addressing deficiencies in the ESG ratings market that have undermined confidence in ratings.
Under the new rules, all ESG ratings providers operating in the European Union (EU) will be supervised by the European Securities Markets Authority (ESMA) or will need to have their ratings endorsed by an EU-regulated rating agency if based outside the EU. Other jurisdictions such as the UK, India, Japan, and Singapore have also introduced voluntary codes of conduct for ESG raters. The move towards regulation is expected to bring greater consistency to the fragmented ESG ratings process and will likely spur consolidation in a market saturated with providers.
With the introduction of new corporate sustainability reporting requirements and global sustainability standards, big businesses operating in Europe are required to disclose more information about their impact on the environment, social issues, and governance practices. As a result, many companies are demanding ESG ratings from suppliers as part of due diligence, leading to increased costs due to the lack of standardization among ratings providers. By promoting transparency and driving consolidation in the ratings agency space, the new regulations aim to establish more standard means of ESG evaluation for companies and suppliers.
The future of ESG ratings remains uncertain as the new regulations are adopted by EU member states. While the emergence of Nationally Recognized Statistical Ratings Organizations (NRSROs) is unlikely, a hierarchy may develop among ratings providers as businesses and investors gravitate towards different agencies. There may also be a segmentation of providers specializing in specific industries or methodologies. The gradual maturation of the space is expected to benefit businesses and stakeholders seeking to objectively measure corporate sustainability risk and benchmark progress towards sustainable operations while potentially reducing operational costs associated with sustainability compliance.
