Provisional EU agreement on ESG rating activity regulation

The EU has reached a provisional agreement on a proposal for a regulation on environmental, social and governance (ESG) rating activities.

The objective is to boost investor confidence in sustainable products.

ESG ratings have an increasingly important impact on the operation of capital markets and on investor trust in sustainable products.

The new rules aim to strengthen the reliability and comparability of ESG ratings by improving the transparency and integrity of the operations of ESG ratings providers and preventing potential conflicts of interests.

⭕ Under the new rules, ESG rating providers will need to be authorized and supervised by the European Securities and Markets Authority (ESMA) and comply with transparency requirements, in particular with regard to their methodology and sources of information.

⭕ The agreement clarifies that ESG ratings encompass environmental, social and human rights or governance factors.

⭕It foresees the possibility to provide separate E, S and G ratings. However, if a single rating is provided, the weighting of the E, S and G factors should be explicit.

ESG risks are drivers of traditional financial risks, so ESG factors are not new to credit assessments.

According to Fitch, ESG considerations have been themes of credit analysis for many years, but until recently have not drawn specific attention.

➡ We are just learning how to change the lens through which we look at companies.

The European Banking Authority’s June 2021 report states that “ESG risks can also impact the financial system and economy as a whole, with potential systemic consequences”.

Fitch underlines that this illustrates why ESG is so pertinent in the credit world today.

Fitch also reminds us that “governance is key”, and has always been of fundamental importance in the credit decision process.

➡ “Governance overall is the most dynamic ESG factor from a credit perspective. Poor governance could severely impact aspects of a company’s risk profile.”

The paper concludes that “it is therefore of critical importance for companies to take a strategic view of governance factors and risks, and incorporate these widely into their long-term planning”.

Therefore, it comes as no surprise that the EU, CSRD and the reporting standards ESRS, focus so much on governance and risk management.

➡ If you are aiming for a good ESG and credit rating, get your IROs (impacts, risks & opportunities) under control.

Sources: EU Press release and FitchLearning