EP and Council reach agreement on new Rating Activities rules

What’s new?

On 5 February 2024, the Council of the EU (the Council) published a press release announcing that it has reached a provisional political agreement (the Agreement) with the European Parliament (the EP) on the proposed ESG Rating Activities Regulation (the proposed Regulation). The EP has published a separate press release.

The Agreement includes compromise on the following aspects of the proposed Regulation:

• the possibility of providing separate E, S and G ratings
• rules on EU and non-EU ESG rating providers
• a lighter registration regime for small ESG rating providers
• new provisions regarding conflicts of interest and
• extending the transparency and integrity rules to financial market participants and financial advisers

Background

As we reported at the time, the EP’s ECON Committee adopted a draft report on the proposed Regulation in December 2023. A compromise agreement has now been reached following negotiations with the Council, the main elements of which are set out below.

What does the Agreement contain?

The Agreement clarifies the following matters:

The possibility of providing separate E, S and G ratings

• Where a single rating is provided, the weighting of each of the E, S and G factors should be made explicit
• The EP’s press release highlights that ESG rating providers must disclose whether their rating addresses both material financial risk to the rated entity and the material impact of the rated entity on the ESG factors, or whether the rating takes account of only one of these

Rules on EU and non-EU ESG rating providers

• EU rating providers would need to obtain authorisation from ESMA
• Non-EU rating providers wishing to operate in the EU would need to obtain one of the following:
  • an endorsement of their ratings by an EU-authorised rating provider
  • a recognition based on a quantitative criterion or
  • registration in the EU on the basis of an equivalence decision concerning their home state and following a dialogue between ESMA and the relevant third-country competent authority

Lighter, optional registration regime for small rating providers for 3 years

• Small ESG rating providers who opt-in will benefit from supervisory fees proportionate to the extent of ESMA’s supervision
• Small ESG rating providers would still need to comply with some general organisational, governance and transparency rules, and they would remain subject to ESMA’s powers to request information and conduct investigations or on-site inspections
• Once small ESG rating providers leave the temporary regime, they would need to comply with the full scope of the proposed Regulation, including the requirements regarding governance and supervisory fees
• For some small ESG rating providers, the Agreement provides that if certain conditions are met, ESMA could exempt a rating provider from some of the requirements but only in duly justified cases

New conflicts of interests provisions

• The Agreement also introduces as a principle a separation of business and activities, with a possibility that ESG rating providers would not need to set up a separate legal entity for certain activities, provided that there is a clear separation between activities and that they put in place measures to avoid potential conflicts of interests
• This derogation would not apply to ESG rating providers that carry out consulting activities, audit activities and credit rating activities
• ESG rating providers may nevertheless develop benchmarks if ESMA considers that sufficient measures have been put in place to address conflicts of interests

Extending the transparency and integrity rules to financial market participants and financial advisers

• Financial market participants (FMPs) and financial advisers will be caught by the proposed Regulation if they provide ESG ratings to third parties. This is being done through amendments to the Sustainable Finance Disclosure Regulation

• The European Commission has made clear, however, that ESG ratings used for internal purposes only will not be captured by the new Regulation

• If FMPs or financial advisers provide ESG ratings to third parties through marketing material they will be required to disclose information on methodology including, among other things, the following:

  • a high level overview of the methodology used including whether analysis is backward or forward looking
  • a high level overview of data sources used, estimates of input data and frequency of data updates
  • information of whether and how methodologies are based on scientific evidence
  • information on the ratings' objective and whether they are assessing risk, impact or other areas
  • whether the rating is aggregated or is a rating of individual E, S and G factors or specific issues
  • the weighting of the aggregated ESG rating, if used, and explanation of the weighting method
  • and any limitations in the data sources used

What happens next?

The Agreement is subject to approval by the Council and the EP before going through the formal adoption procedure.

The Regulation will start to apply 18 months after its entry into force.