The EU’s New ESG Rating Regulation Reveals Familiar Regulatory Patterns

Back in June 2023 when the EU revealed its proposed regulations for ESG Rating Agencies, I pondered whether the EU had gone far enough. Now, the EU has confirmed and published its final Regulation for ESG Rating Activities, titled Regulation (EU) 2024/3005 on the transparency and integrity of Environmental, Social and Governance (ESG) Rating activities. Many fantastic scholars have already opined on the Regulation and reviewed it more than adequately – see the excellent Prof. Andreas Rasche’s review here – so instead I will assess some more nuanced takeaways from the Regulation (and also respond to some issues identified in the 2023 commentary).

The first issue identified in the 2023 commentary was that the Regulation has seemingly decided to avoid bring ‘Second-Party Opinions’ (SPOs) within the regulatory perimeter, which I had indicated was a missed opportunity. This has been maintained in the final Regulation, with SPOs being categorically placed outside of the regulatory perimeter. I discussed why this is an important failure in a recent chapter as part of Danny Busch et al.’s Sustainable Finance in Europe book (available here) and you can also find an interesting discussion on SPOs here via Alexander Coley. The effect of SPOs and their growing importance, together with the prospective conflict of interests that arise from their provision, mean this is very much a missed opportunity for the European legislators.

The second issue identified was that, like the Credit Rating regulatory frameworks, the Regulation was allowing anonymity to dominate the regulatory reviewing system. In the credit rating regulatory frameworks, regulators are permitted to only publicise the broad category of those who infringe the rules – for example, they will say that a ‘large credit rating agency’ has broken this rule or that rule, or that a ‘medium-sized credit rating agency’ has transgressed. I have long since called for this practice to be stopped and that those guilty of breaching the rules are adequately identified for the public. It was interesting to see whether the legislation would force the regulator – ESMA – to break this practice, but no such luck. In the final Regulation, there are only two references to the ‘annual report’ the regulator must file, and no details about particular elements within it.

This is a particular theme of the Regulation which warrants scrutiny. The most obvious section to examine is Article 28, which reads: ‘in carrying out their duties under this Regulation, ESMA, the Commission or any Member States public authorities shall not interfere with the content of ESG Ratings or methodologies’. This same sentiment is seen across each and every credit rating-focused Regulation and for good reason. Any perceived amount of interference has the potential to negatively affect one of the core tenets of a ‘rating’ system – the rating must be produced by an independent and impartial third-party. There is a balance that a Regulation must find and the question here is whether the EU have found that balance.

It appears that the answer depends on one’s perspective. I do not believe they have gone hard enough, leaving out key elements like SPOs, as well as providing quite a soft-touch approach to the general constraining sentiment of the Regulation. However, consider it from the EU’s perspective… they are essentially first out of the gate (in terms of a full formal piece of legislation for leading ESG Raters), this is the first time they have regulated the industry, and the industry itself is quite the moving target. In between the proposal and the final Regulation, Moody’s have completely vacated the space, leaving really only two main players – MSCI and S&P. Also, it is becoming abundantly clear that the ESG Rating game is perhaps not as impactful as people first feared, with it starting to resemble a side-business for those who primarily sell indices. Add to this that, across the board, there appears to be a general retreat from ESG by the business sector (even before Donald Trump re-assumes the Presidency in the US). Take all that and put it together, the real question becomes whether the EU have just regulated the industrial version of a ghost – it was there when they started, but is it any longer?