Does The EU's New ESG Regulation Offer Treasurers a Chance to Choose Which Ratings Provider to Use?

The European Union (EU) has recently taken a significant step in promoting environmental, social, and governance (ESG) practices by finalizing a regulation that aims to impose standards and control over ESG ratings.

As sustainability reporting becomes mandatory under the EU corporate sustainability reporting directive (CSRD), the transparency of ESG performance will play a crucial role in evaluating the overall value of businesses. Additionally, the implementation of International Sustainability Standards Board (ISSB) guidance within and outside Europe will further emphasize the significance of ESG assessments in attracting investment.

Therefore, treasury departments must have a clear understanding of their company’s and partners’ ESG strengths and weaknesses, as it directly impacts the business’s overall value.

Regulating ESG Ratings Agencies

To address the proliferation of ESG ratings agencies and ensure their quality and reliability, the EU has proposed a regulation that focuses on agencies offering public assessments for companies and investors.

These agencies will be required to obtain authorization and supervision from the European Securities and Markets Authority (ESMA). By imposing regulation and oversight, the EU aims to enhance the quality and objectivity of ESG ratings, providing better protection for investors and ensuring market integrity.

One of the key objectives of the EU’s ESG ratings regulation is to prevent and mitigate potential conflicts of interests among ratings providers. The regulation emphasizes that ESG rating agencies should provide independent, objective, and high-quality ratings.

To enhance transparency, the European Parliament has backed amendments that require agencies to disclose the factors considered (E, S, and G), their relative importance, and alignment with international agreements and standards. This disclosure enables investors and businesses to make informed decisions based on the ESG ratings’ credibility and relevance.

Rating Methodologies and Validation

While the EU does not prescribe specific rating methodologies, the proposed regulation emphasizes the need for rigorous, systematic, and objective approaches. The rating methodologies should also be subject to validation to ensure their accuracy and reliability.

This requirement aims to standardize the assessment process and reduce discrepancies among different agencies. By setting clear expectations for rating methodologies, the EU intends to provide a more consistent and comparable ESG rating framework.

To further strengthen the transparency associated with ESG ratings, the European Parliament has proposed additional disclosure requirements for ESG rating providers. These requirements include disclosing methodologies, models, key rating assumptions, stakeholder engagement practices, and how contradictory or subjective information is handled.

By providing comprehensive information about their assessment processes, ESG rating agencies can enhance their credibility and build trust among investors and businesses.

Optional Registration Regime

To balance the regulatory burden on small ESG rating providers, the EU ministers have proposed amendments to create a lighter and temporary registration regime. This regime, lasting for three years, aims to accommodate existing small rating providers and new entrants into the market.

These providers will be exempt from ESMA supervisory fees but will still need to comply with general organizational and governance principles, transparency requirements, and provide information to ESMA upon request.

Benefits for Treasury Professionals

The EU’s initiative to regulate ESG ratings agencies can bring significant benefits to treasury professionals. According to KPMG, the lack of a standard definition for sustainability has led to considerable differences in the factors included and their assessment among rating agencies.

The EU’s regulation can address this issue by promoting standardized methodologies and validation processes. This standardization will enable treasury professionals to make more accurate and informed assessments of their company’s ESG performance and potential partners, ensuring the alignment of values and goals.

Recognizing the need for international consistency in ESG ratings, the International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG) have introduced a voluntary code to promote transparency, good governance, and the management of conflicts of interest in the ESG ratings sector.

Supported by the UK’s Financial Conduct Authority (FCA), this code aims to increase trust in the ESG data and ratings market by aligning with international standards and best practices.

Additional Information:

• The CSRD (EU corporate sustainability reporting directive) aims to make sustainability reporting mandatory for EU companies.
• The International Sustainability Standards Board (ISSB) provides guidance on sustainability reporting.
• The European Securities and Markets Authority (ESMA) is responsible for the authorization and supervision of ESG ratings agencies.
• The voluntary code introduced by the ICMA and IRSG promotes transparency and good governance in the ESG ratings sector.