Commission publishes report following ESG ratings consultation

On 3 August 2022, the European Commission published a Summary Report (the Report) following its targeted consultation on the functioning of the ESG ratings market in the EU and on the consideration of ESG factors in credit ratings.

The consultation, which was carried out between 4 April and 10 June 2022, received 168 responses. Most of these came from users of ESG ratings, whose view was that the market does not currently function well.

The main takeaway from the Report is that most respondents considered that intervention is necessary. A large majority of respondents support a legislative intervention and believe that ESG rating providers should be subject to some form of authorisation or registration regime in order to offer their services in the EU.

What was the consultation about?

Forming an integral part of the EU’s renewed sustainable finance strategy, the consultation sought to gain a better understanding of how ESG ratings function and how credit rating agencies incorporate ESG risk in their creditworthiness assessment.

What was found?

The findings of the consultation can be divided into five main categories;

1. Use of ESG ratings and dynamics of the market

Most respondents said that they;

• use a combination of overall ESG ratings with E, S , G or even more granular ratings;
• value transparency in data sourcing and methodologies, accuracy and reliability;
• expect the ESG ratings market to grow (respondents consider the decisive factors in this growth to be growth in demand from investors in ratings of companies for their investment decisions);
• expected to increase their usage of ESG ratings (this expected increase is most marked for investor users);
• use ESG ratings mostly or exclusively from large market players; and
• consider that the current market conditions make it difficult for smaller market players to enter the market and to remain competitive.

2. Functioning of the ESG ratings market

When it comes to the functioning of the ESG ratings market, a large majority of the respondents considered that;

• the market is not functioning well today;
• there was a problem with the lack of transparency of the methodologies used by providers;
• there are significant biases with the methodology used by providers; and
• the market is prone to potential conflicts of interests.

3. Intervention in the ESG ratings market

Almost all respondents:

• considered that intervention is necessary;
• supported a legislative intervention;
• indicated that the main element to be addressed by the intervention should be improving transparency on the methodology used (followed by avoiding potential conflicts of interests, improving reliability and comparability of ratings, clarifying objectives of different types of ratings, and clarifying what is meant by and captured by ratings); and
• considered that ESG rating providers should be subject to some form of authorisation/registration regime in order to offer their services in the EU.

4. Incorporation of ESG Factors in credit ratings

A large majority of respondents said it was important to them to understand to what extent individual credit rating actions had been influenced by sustainability factors.

Only one Credit Rating Agency (CRA) saw the need for further detailing of ESMA Guidelines on disclosures. In the case of EU intervention, the majority of CRA saw a risk in too much prominence given to ESG factors as compared with other factors relevant for the assessment of creditworthiness.

5. Intervention in the credit ratings market

Finally, when it came to enabling users’ understanding of how ESG factors influence credit ratings is concerned, the majority of respondents did not consider market trends and ESMA Guidelines to be sufficient. However, a slight majority favoured a non-legislative approach ie further detailing ESMA Guidelines and/or further supervisory actions by ESMA.

What’s next?

The Commission is planning to reflect these results in its preparation of any further initiative on the topic.