The European Commission has proposed new rules to force environment, social and governance (ESG) ratings providers to adhere to stricter requirements, in an effort to improve transparency.
Rating agencies have come under file for their opaqueness and weak governance as investments in ESG funds have grown exponentially.
The latest figures from Refinitiv Lipper show total assets under management across all ESG funds stood at $33.3 trillion at end-March.
ESG ratings typically measure a company’s exposure to and management of financially relevant ESG factors.
This can range from carbon emissions to data privacy and board diversity. Every provider will weight these factors differently. Only a few will measure a company’s impact on the environment and the outside world.
Critics note that this leads to confusion among investors who may be surprised that an ESG fund can hold oil or mining stocks, or wonder why the same electric carmaker can be simultaneously ranked as less and more ESG-friendly than a combustion engine-reliant rival.
This explains why a survey commissioned by the Commission last year found that eight in ten said the system was not functioning well. In addition, over 90% believed that intervention was needed.
Under the proposals, providers will have to publish their methodologies as well as disclose potential conflicts of interest, separating business and activities.
They will be regulated by the European Securities and Markets Authority (ESMA) who could force them to end a breach of the rules, comply with an investigation, or conduct on-site inspections,
ESMA will also be able to impose a fine of up to 10% of the total annual net turnover of the ratings provider. This could be for a maximum period of six months and equal to 3% of the average daily turnover generated by the ratings agency in the year prior to the penalty.
ESG ratings providers would also be subject to a fee covering all administrative costs incurred by ESMA.
Total annual costs to conduct new functions would increase for ESMA by approximately €3.7-3.8m, according to the draft proposal document.
In addition, ESMA could revoke or suspend the authorisation of an ESG rating if rules are infringed or the provider has not conducted its business for a period of nine months.
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