The European Union will ask the world’s biggest providers of ESG ratings to keep their scoring services separate from the rest of their business as part of a sweeping overhaul intended to reform the industry, according to a draft document seen by Bloomberg News.
(Bloomberg) — The European Union will ask the world’s biggest providers of ESG ratings to keep their scoring services separate from the rest of their business as part of a sweeping overhaul intended to reform the industry, according to a draft document seen by Bloomberg News.
The planned regulation would affect financial-market conglomerates that combine the sale of environmental, social and governance ratings with other services such as consulting, issuance and sale of credit ratings, as well as the development of benchmarks, according to the draft document, which may still change before it’s formally unveiled next week.
ESG ratings providers could face fines of up to 10% of total annual net revenue for violating the new rules, under the draft proposal which lists several new requirements for the industry. The European Securities and Markets Authority also could nullify authorization to provide ratings. The new legislation is likely to go into effect during the second half of 2024, according to the draft.
The introduction of formal rules marks a huge shift for an industry that’s enjoyed years of unfettered growth and steered vast sums of capital into investments without any real oversight. In its draft proposal, the EU said “the current ESG rating market suffers from deficiencies and isn’t functioning properly.” As a result, “confidence in ratings is being undermined,” it said.
The proposal, which still needs to be negotiated by the European Parliament and EU member states, has implications for companies including Moody’s Corp., MSCI Inc. and S&P Global Inc., all of which offer ESG ratings in combination with other services.
Bloomberg News parent Bloomberg LP provides access to third-party ESG ratings, alongside its proprietary ESG scores and other services.
The timeline for passing the proposal, which was drafted by the European Commission, is tight with EU elections scheduled for next June.
ESG ratings providers will be expected to disclose the following:
- Overview of methodologies, including whether analysis is backward or forward-looking, and if they are based on scientific evidence
- Statement on whether the rating’s objective is to score risks, impact or “some other dimensions”
- Information on whether the rating aggregates environmental, social and governance factors or applies to only one
- If an aggregated score, information on the weighting of E, S and G in the calculation
- Use or not of artificial intelligence to collect data and/or assign scores
- Any limitations on data sources
The EU Commission said its research found that “each ESG rating provider follows its own rules, with a lack of clarity as to what they do and how they do it.” Due to such failings, calls for reform have been longstanding. Back in November 2021, the International Organization of Securities Commissions called for more oversight.
The EU wants ratings’ providers to make clear and public what their data sources are and what methodologies they use to assign scores. It also wants raters to detail the characteristics of their scores. The information can then be used by investors and other users to select ratings’ companies, according to the draft proposal.
The EU isn’t proposing that it tell ratings providers how to score companies, with regulations instead focusing on issues of transparency, consistency as well as conflicts of interest.
The EU Commission identified 59 ratings companies, roughly half of which are located in Europe. It didn’t single out any companies by name.
Providers would be required to be authorized by the European Securities and Markets Authority to operate in the EU. The proposal excludes ESG ratings designed by banks and other financial market participants for in-house only use.
Demand for ESG ratings is expected to climb as companies comply with the EU’s expanding suite of sustainability legislation. That includes from issuers of green bonds under the EU’s new Green Bond Standards.
The European Commission is set to present a sustainable package next week that also includes new taxonomy criteria covering environmental objectives and plans to boost transition finance.
(Adds more about European Commission’s plans in 14th paragraph. An earlier version was corrected to say Bloomberg LP provides ESG scores.)
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