MEPs adopt significant changes to draft rules on Environmental, Social and Governance ratings

MEPs want separate E, S and G ratings and a company’s potential negative external effects better reflected.

Voting in the Economics and Monetary affairs committee on Monday, MEPs, led by the rapporteur Aurore Lalucq (S&D, FR), made significant changes to the rules proposed by the Commission setting up a system to regulate environmental, social and governance (ESG) rating activities.

The committee position was adopted with 33 votes in favour, 1 against and 3 abstentions. They then approved that the text be the mandate for negotiations with the member states.

More transparency – Break down the ESG rating

Rating providers should refrain from aggregating the E, S and G scores, as this could obscure poor performance on any of these individual metrics. In particular, ESG ratings providers should disclose whether E, S, or G factors are taken into account, or an aggregation thereof, the rating given to each relevant factor, and the weighting each of these factors is given in the aggregation.

Moreover, ESG ratings providers should provide information on whether the rating considers, amongst others, the alignment with the objectives set in the Paris agreement for the “E” factor, the compliance with International Labour Organisation core conventions on Right to Organise and Collective Bargaining for the “S” factor, and the alignment with international standard on tax evasion and avoidance for the “G” factor.

More transparency – Promote the ‘double materiality’ approach

The adopted report adds provisions to ensure that the rating products should explicitly disclose the rated entity’s materiality, i.e. whether the delivered rating addresses both material financial risk to the rated entity and the material impact of the rated entity on the environment and society, or whether it takes into account only one of these.

In this way, ESG raters are encouraged to address the material impact of the rated entity on the environment and society in general more than is currently the case.

More overall transparency

ESG rating providers should also disclose information to the public on the methodologies, models and key rating assumptions which those providers use in their ESG rating activities and in each of their ESG ratings product.

Information should also be made available about the limitations of the information available to the rating providers, including information about engagement with the various stakeholders of a rated entity and how contradictory, incomplete or subjective information is handled.

Boosting competition

In a bid to encourage competition among ESG rating providers and fostering an environment where smaller rating providers can enter the market, an entity seeking to obtain more than one ESG rating should choose at least one ESG rating provider with a market share below 15%.

Quote

After the vote Ms Lalucq said, “I welcome the rapid adoption of this report by a large majority, less than a month after its presentation. A regulation of the ESG rating sector was necessary and expected by all the stakeholders in order to strengthen the ESG European sector. It is essential to ensure confidence in this sector and to make sure that ESG criteria are useful tools at the service of the social and ecological transition. This makes the EU the first power to adopt a regulation in this area, defending a singular position on the matter, including the double materiality approach.”

Background

The widespread popularity and interest in ESG goals is to be welcomed as a useful tool for redirecting investment towards more sustainable companies and projects. But it also presents the risk of mis-selling and greenwashing if ESG data lacks standardized and harmonized criteria. Therefore, ensuring accurate and reliable ESG information is key. The ESG ratings market currently suffers from a lack of such transparency.

This regulation will complement other already existing legislation such as the Sustainable Finance Disclosure Regulation, the Taxonomy Regulation, the Corporate Sustainability Reporting Directive, and the Green Bonds regulation.