The Call for Evidence is one of a number of measures the EU is taking as it aims to strengthen the reliability of ESG ratings.
By Paul A. Davies, Sarah E. Fortt, Betty M. Huber, Michael D. Green, and James Bee
On 4 April 2022, the European Commission (Commission) published a call for evidence (Call for Evidence) to solicit responses to inform the Commission on the dynamics of the ESG ratings market in Europe, including on the use and objectives of ESG ratings and the interplay between larger and smaller market players.
Given the growing interest in ESG issues from investors in recent years, ESG ratings and similar products have become increasingly popular as an independent and easy-to-use data point for investors to compare companies’ ESG credentials. However, this popularity has led to concern from some market participants and regulators as to the currently unregulated nature of the ESG rating provider market. This unregulated nature has in turn led to concerns regarding the consistency and quality of ESG ratings, as well as the ability to compare ESG ratings from different providers who often use materially different methodologies.
The Commission has previously looked at this issue as part of its consultation in early 2021 on its renewed sustainable finance strategy. The Commission asked stakeholders about their views on the quality and relevance of ESG ratings for their investment decisions and the need for action at EU level. Respondents indicated that better comparability and increased reliability of ESG ratings would enhance the efficiency of this fast-growing market, leading the Commission to issue the Call for Evidence.
As stated in the Call for Evidence, the Commission hopes to use the information it garners from the Call for Evidence to inform its next steps in relation to the possible regulation of ESG ratings and their providers. The Commission indicates in the Call for Evidence that it intends to strengthen the reliability and comparability of ESG ratings and is exploring the use of non-binding guidelines as well as potential new legislation to regulate the operations of ESG rating providers.
In parallel to the Call for Evidence, the European Securities and Markets Authority (ESMA) issued a separate call for evidence in February 2022 on ESG ratings providers and the possible costs of regulatory supervision for these entities, which the Commission describes as “complementary” to its own Call for Evidence, demonstrating the acknowledgement at EU level of the need for coordinated action between institutions in this area. The Commission has also separately launched a public consultation in the form of a questionnaire on the functioning of the ESG ratings market in the EU and on the consideration of ESG factors in credit ratings. The Commission will consider the responses to this consultation alongside the Call for Evidence.
The variety of initiatives that the Commission and other EU institutions are undertaking is clear evidence of the importance being placed on the topic of ESG ratings as they continue to grow in prominence.
The Call for Evidence will be open for input from market participants until 6 June 2022. Whether the evidence gathered will lead to non-binding guidelines or formal regulatory action at EU level, such as that in India, remains to be seen. From the US perspective, an SEC report released in February 2022 identifies a handful of risks when entities providing credit ratings incorporate ESG factors into their credit determinations. The subjects of the SEC report were traditional credit ratings agencies, and not the specialist ESG rating agencies that continue to develop in this market, but a consensus seems to be growing in many jurisdictions that the popularity of ESG ratings has created certain market risks that need to be addressed.
Latham & Watkins will continue to monitor the development of regulation and guidelines concerning ESG rating providers.
Submit a comment about this post to the editor.