With sustainability reporting in the EU becoming mandatory under the EU corporate sustainability reporting directive (CSRD), ESG performance is set to become more transparent when treasurers evaluate the performance of their own companies, potential commercial partners and investors. And the implementation of International Sustainability Standards Board (ISSB) guidance inside and outside Europe, will make ESG assessments more important, notably for attracting investment.
For treasury departments, knowing their company’s and its partners’ ESG strengths and weaknesses will therefore be an increasingly important material issue affecting a business’ overall value. So, the attempt by the EU to impose some order on the proliferation of ESG ratings agencies could be helpful.
This has been debated swiftly, in Brussels terms, with the EU Council of Ministers (in December) and European Parliament (in November) approving their negotiating stances to finalise a legal text, based on a European Commission proposal made in June 2023. A key element of the proposal was that ESG ratings agencies offering public assessments for companies and investors be regulated – advisers whose guidance remains private are not covered by the proposed law. The Commission has said that agencies working in public should be authorised and supervised by the European Securities and Markets Authority (ESMA).
Proposing the regulation, the EU executive said: “This will ensure the quality and reliability of their services to protect investors and ensure market integrity.” Also, while the Commission does not want to say how agencies should assess ESG, the regulation, as proposed, says they should “use rating methodologies that are rigorous, systematic, objective and subject to validation...”
The attempt by the EU to impose some order on the proliferation of ESG ratings agencies could be helpful
A key goal is to prevent and mitigate against potential conflicts of interests, said the Commission: “ESG rating providers should ensure that they provide ESG ratings that are independent, objective and of adequate quality.”
After its initial deliberation, the European Parliament backed amendments designed to boost transparency associated with ratings agencies. MEPs said that rating providers should disclose whether ‘E’, ‘S’ and ‘G’ factors are considered and their relative importance within their assessments. They also want agencies to declare how their ratings align with the UN Paris Agreement on climate change (‘E'); International Labour Organization (ILO) conventions ('S'); and international standards against tax evasion or tax avoidance (G).
MEPs also want agencies to declare whether their assessments focus on single materiality (the impact of ESG issues on a company); or double materiality (also considering a company’s impact on ESG issues at large). MEPs also want ESG rating providers to disclose their methodologies, models and key rating assumptions; how they engage with stakeholders; and how they deal with contradictory, inconsistent or subjective information.
By contrast, EU ministers have tried to ease the regulation’s operation, proposing amendments creating a lighter, temporary and optional registration regime of three years for existing small ESG rating providers and new small markets entrants. If this proposal survives the upcoming ‘trilogue’ negotiations with the two other EU institutions, these ratings firms will be exempt from ESMA supervisory fees. They will instead just comply with some general organisational and governance principles, plus transparency requirements, and must supply information to ESMA upon demand.
The benefits for treasury professionals if the EU gets this initiative right are real, said a KPMG briefing issued in July. It commented: “There is no standard definition for the concept of sustainability, which is the central object of the ratings. This means that each rating agency can use its own individual understanding of sustainability as a basis for its assessment, which leads to considerable differences in terms of the factors included and their assessment.”
Such concerns were behind another ratings initiative, in this case voluntary, announced in December by the Switzerland-based International Capital Market Association (ICMA), working with the UK-based International Regulatory Strategy Group (IRSG). This code is designed to promote transparency, good governance, management of conflicts of interest, strengthening systems and controls in the ESG ratings sector.
It has been supported by the UK’s Financial Conduct Authority (FCA), whose ESG director Sacha Sadan said: “With its strong focus on international consistency, this industry-owned code will play a key role in increasing transparency and trust in the ESG data and ratings market.”
See also: Corporate ESG disclosures in FCA focus
Keith Nuthall is a business and finance journalist specialising in international regulation