By ESG Analyst Cameron Toy-Kluger
EU Flag | via FinTech Global
Earlier this month, the European Council and Parliament of the EU reached a bombshell agreement to begin regulating ESG rating activities. Committing to introducing a greater deal of scrutiny into ESG disclosures, the deal is a promising step toward ensuring greater corporate accountability amid recent controversies surrounding ‘greenwashing’ and sustainability inflation.
Leading Up to the Deal
In early 2021, the European Securities and Markets Authority (ESMA), an EU-based authority responsible for improving the security and functioning of financial markets, delivered a formal letter to the EU’s ESG commission warning against the massive unregulated and unsupervised growth in the billion-dollar ESG rating industry. The ESMA proposed that it be responsible for supervising providers of ratings to verify the honesty and consistency of their services.
Later that July, the European Commission launched a new Sustainable Finance Strategy which adopted a breadth of new initiatives to future-proof the EU’s financial institutions. The strategy included a pledge to take action regarding the then-infant industry of ESG reporting to safeguard against dishonest practices. The Commission requested that the ESMA begin evaluating various providers of ESG rating services.
How Does the Agreement Work?
On the 5th of February, the ESMA had its wish granted. The new provisional agreement would bring private providers of ESG ratings under the jurisdiction of the ESMA, requiring them to be subject to a host of new transparency requirements. The deal ensures that ratings providers in the EU obtain authorization from the ESMA or providers outside the EU be recommended by an EU-authorized provider. Measures are also in place to avoid conflicts of interest by requiring a clear legal separation between ESG rating and other activities within a business.
The agreement hopes to promote the idea of “double materiality” already embedded into the EU’s sustainability disclosures. The notion encourages providing equal consideration to impact from both a financial and environmental
perspective. To that end, the EU deal requires that ESG raters explicitly state the weighting of E, S, and G when providing a rating.
Relevance & Next Steps
In a world where regulating the ESG industry is becoming increasingly complex, a steadfast agreement like that of the EU could send reverberations throughout the world of sustainable finance. Known for their groundbreaking legislation in decarbonization and renewable energy, it’s no surprise that the EU is one of the first global bodies to take steps to prevent greenwashing.
The formal agreement provides some hope that fellow global powers will follow suit to advance corporate accountability. The new rules still need to be formally approved by the EU Council and Parliament, but they will likely enter into force sometime in 2025.
References:
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