Agreement on Proposal for Regulation on Environmental, Social and Governance (ESG) Rating Activities

On 5 February 2024, the EU Council and EU Parliament agreed to new regulation on Environmental, Social and Governance ESG rating activities, stated the European Council in a press release. Environmental, social and governance issues are commonly referred to by the acronym ‘ESG’, and assess companies sustainability risks as well as their environment and societal impact. The EU’s regulation aim to overcome issues chief among which are ‘(i) the lack of transparency on the characteristics of ESG ratings, their methodologies and their data sources and (ii) the lack of clarity on how ESG rating providers operate.’

In many cases, the ESG risks are linked to the long-term strategic planning and financial performance of companies, and can be used by investors in financial markets to assess corporate governance.

Corporate governance is the set of structures, rules and processes that determine how a company is operated. In recent years the concepts of governance have expanded to include the concept of ‘double materiality’, meaning that a company will report both sustainability factors affecting the company’s own business as well as sustainability factors which affect society and the environment as a whole. Companies are responsible for reporting both on their own activities and on the activities of suppliers and customers which have or could have significant impacts.

A key high-level sustainability reporting requirement for companies headquartered or operating in the European Union is the EU Corporate Sustainability Reporting Directive, known under the acronym CSRD, while more specific reporting requirements on topics including climate impact, pollution, water, biodiversity and resource use and circular economy can be found in the European Sustainability Reporting Standards. Once companies report their sustainability data publicly, their data can be evaluated and rated by various rating agencies.

‘Increasing investor confidence through transparent and regulated ESG ratings can have a significant impact on our transition to a more socially responsible and sustainable future,’ said Vincent Van Peteghem, Belgian Finance minister, quoted in a Reuters article. The article noted further that environmental ratings must note whether a company aligns with the Paris Agreement on reducing carbon emissions. The rules mean that ESG ratings agencies will now be overseen and permitted by the European Securities and Markets Authority.

Full text of the EU Council’s proposal can be found here