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EU Approves New ESG Ratings Regulation to Enhance Transparency and Investor Trust

EU Approves New ESG Ratings Regulation to Enhance Transparency and Investor Trust

EU Approves New ESG Ratings Regulation to Enhance Transparency and Investor Trust
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  • Boosting transparency: The new regulation requires ESG rating providers in the EU to be authorized and supervised by the European Securities and Markets Authority (ESMA) and comply with strict transparency standards.
  • Preventing conflicts of interest: A clear separation of business and activities is mandated to ensure the integrity and reliability of ESG ratings.
  • Global alignment: ESG rating providers outside the EU must obtain recognition or endorsement to operate within the Union, fostering consistency and comparability in ESG ratings globally.

The Council of the European Union has approved a groundbreaking regulation to enhance the transparency, consistency, and comparability of environmental, social, and governance (ESG) ratings. This move aims to bolster investor confidence in sustainable financial products by addressing key concerns about the reliability of ESG assessments.

What this means:

ESG ratings evaluate a company’s or financial instrument’s sustainability profile by examining its societal and environmental impact and exposure to sustainability risks. Given their growing influence on capital markets and sustainable investments, ensuring their credibility has become a priority.

Key provisions in the regulation include:

  1. Authorization and supervision:
    ESG rating providers within the EU must now be authorized and monitored by the European Securities and Markets Authority (ESMA). These providers will also face transparency requirements about their methodologies and information sources.
  2. Global participation standards:
    Providers outside the EU must meet specific criteria, such as obtaining endorsements from EU-authorized entities or being listed in the EU registry based on equivalence decisions.
  3. Conflict of interest prevention:
    To ensure impartiality, the regulation mandates the separation of business and rating activities.

Quote from the Council:

“The new rules aim to strengthen the reliability and comparability of ESG ratings by improving the transparency and integrity of the operations that ESG rating providers carry out and by preventing potential conflicts of interest.”

RELATED ARTICLE: UK Gov Proposes Regulation for ESG Ratings Providers to Ensure Transparency

Related Developments:

The UK is advancing its own regulatory framework for ESG ratings providers, aligning with international standards like those set by IOSCO. Legislation is expected by early 2025, with full implementation within four years.

Key insights from the UK’s initiative:

  • Support for regulation:
    95% of consultation respondents backed the need for clear methodologies and transparency. However, smaller firms expressed concerns about potential cost burdens.
  • Scope and implementation:
    The regulation will encompass both UK-based and overseas providers engaging with UK users, ensuring consistency across global markets.

Tulip Siddiq MP, Economic Secretary to the Treasury:

“Bringing ESG ratings providers into regulation will boost investor confidence, reduce greenwashing, and address the lack of transparency highlighted in responses to the government’s consultation.”

Global alignment: The UK’s framework aims to align with international frameworks like the EU’s Sustainable Finance Disclosure Regulations (SFDR) and ISSB standards, ensuring consistency across markets.

Next Steps:

The regulation will be published in the EU’s Official Journal and will take effect 20 days later. It is set to apply 18 months after its entry into force, giving stakeholders time to align with the new standards.

Background:

This regulation follows a June 2023 proposal by the European Commission and an agreement with the European Parliament under the ordinary legislative procedure. It marks a critical step in standardizing ESG assessments and fostering trust in sustainable finance.

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