Do the EU’s new ESG rules make ratings more reliable?

In the words of former European Central Bank President Mario Draghi, the EU needs to invest an “enormous amount of money in a relatively short time” to deal with the environmental challenges it is facing. The former ECB’s President emphasised the need to mobilise private capital on top of public money.

Key to activating private funds is to ensure it goes in the right places. Last month the European negotiators reached a deal on how to regulate the ESG ratings market in the EU.The regulation has its shortcomings but this undoubtedly marks a first step in the right direction. 

At present, ESG ratings have the potential to steer capital flows towards sustainable investments, but they just are nowhere near portraying a credible picture of companies’ sustainability performance. 

Heavy polluting oil and gas and transport companies still obtain ludicrously high scores, despite their poor track record on environmental and social matters. 

Meant to “strengthen the reliability and comparability of ESG ratings” and aimed at “preventing greenwashing or other types of practices which may be misleading,” the agreement paves the way to increased transparency. That will hopefully empower investors to make more informed decisions. 

According to the new provisions, ESG raters falling under the scope of the regulation, including US ESG rating giants like MSCI and Morningstar, will now need to give a clear indication of whether their ratings cover just the company’s exposure to E, S and G risks, or also its environmental and social impact on the outside (real world) world. They will also have to disclose whether they provided scores coherent with existing European laws and major international agreements like the Paris Agreement on climate and the International Labour Organisation core conventions. 

The newly introduced minimum transparency requirements and the provisions against conflicts of interest represent the backbone of this regulation and will hopefully help improve the EU ESG market. 

Unfortunately, the European Commission and the co-legislators dismissed the opportunity to establish harmonised methodologies. This will prevent users from having more clarity regarding how raters assign ratings, allocate weights to each environmental (E), social (S), and governance (G) factor, and assess the data they use. However, this decision might be reconsidered in a future review. 

All along the process, several lobbying attempts, including by the US ratings giants themselves, sought to make these rules even weaker. To mention one, they almost succeeded in regulating scoreboards for non-commercial purposes – like T&E’s HDV ranking –  exactly the same way as rankings put forward by large for-profit multinational companies. The attempt was blocked at the very last minute.

Despite all that, T&E successfully led a coalition of civil society organisations and relentlessly engaged EU policy-makers managing to affirm its leading role in the public debate. Our persistent efforts ultimately managed to preserve the foundations of this legislation and have a positive impact on the final outcome.  

But the job is not done yet, Europe must continue to defend users against corporate interests and uphold ambitious rules to prevent further greenwashing. 

Ahead of the upcoming EU elections, the sustainable finance debate must remain on top of the future European policy agenda. Without a renewed focus on mobilising private capital, the calls from Mr Draghi won’t be met, and neither will the ambitious environmental goals.