New EU Regulation for ESG Ratings: Strengthening Transparency and Integrity
1 January 2025 – the new EU Regulation for ESG ratings will come into effect, becoming fully applicable by 2 July 2026. This Regulation aims to enhance the transparency and consistency of ESG assessments, helping to reduce the risks of greenwashing and increasing investor confidence. For businesses, this means reviewing existing disclosure processes and implementing new standards to meet the requirements regarding methodologies and data sources.
On 2 July 2026, a new regulatory framework governing Environmental, Social, and Governance (ESG) ratings will come into effect, further enhancing transparency and consistency across ESG assessments. This new EU Regulation aims to align ESG ratings with established methodologies and improve their comparability, providing greater clarity for investors and stakeholders in decision-making and risk management. The framework also seeks to mitigate the risks of greenwashing and social washing by introducing rigorous transparency requirements.
Key Aspects of the New Framework:
- Scope of the Framework: The Regulation applies to ESG rating providers both inside and outside the EU. This includes entities that issue ESG ratings to regulated financial undertakings or public authorities in the EU. Non-EU providers must comply with equivalence, endorsement, or recognition regimes to operate within the EU market.
- Definition of an ESG Rating: The new regulation provides a detailed definition of an ESG rating as an opinion or score based on established methodologies and a defined ranking system. Ratings assess a rated item’s material impact on ESG factors and financial risks, reflecting the double materiality principle. Ratings can apply to a wide range of financial products, such as investment funds, insurance products, and pension schemes.
- Exemptions from the Framework: Certain activities are excluded from the scope of the regulation, including ESG labels that do not involve ESG ratings, and internal ratings used exclusively within regulated financial entities for in-house purposes.
Implications for ESG Rating Providers and Market Participants
Both EU-based and non-EU ESG rating providers will be subject to strict obligations under the new framework. Providers will need to comply with transparency requirements, including disclosing the methodologies, data sources, and potential conflicts of interest used in their ratings. They must also ensure that entities referencing their ratings in marketing materials include a link to the relevant rating information.
EU financial market participants, including fund management companies and investment firms, which issue and distribute ESG ratings as part of marketing communications, will need to ensure compliance with the new disclosure obligations. These entities will have to include detailed information about the methodology, data sources, and assumptions underlying their ESG ratings in their public communications.
The regulation introduces a mechanism allowing the issuer of a financial product to verify the data used in ESG ratings before the rating is issued. While the issuer can identify factual errors in the dataset, they cannot influence the rating outcome or methodology.
Source: EU ESG Ratings Regulation, The introduction of a new EU framework, December 2024
SFDR Amendment
The Sustainable Finance Disclosure Regulation (SFDR) will also be amended to align with the new ESG rating framework. Financial market participants and advisors who issue ESG ratings will be required to comply with the new transparency and disclosure rules under the SFDR, ensuring that ESG ratings provided to third parties meet consistent and high standards of disclosure.
What to Expect Ahead:
- With the Regulation coming into force on 1 January 2025 and becoming fully applicable by 2 July 2026, there is a clear timeline for entities to ensure they comply. Providers will need to adapt their systems, review their existing processes, and potentially overhaul how they disclose ESG ratings to align with these new requirements.
- In the months following the Regulation's entry into force, the European Securities and Markets Authority (ESMA) will submit draft Regulatory Technical Standards (RTS) for review. These standards will provide detailed guidance on how information should be disclosed by rating providers and financial market participants.
Conclusion
The EU's new ESG ratings framework marks a critical step towards more reliable, transparent, and comparable ESG assessments. By establishing clear rules and ensuring consistent data, the Regulation is designed to enhance trust and accountability in ESG ratings, enabling better decision-making and fostering a more sustainable financial ecosystem. As the landscape of ESG reporting evolves, these changes will help safeguard against misleading information and promote more informed, responsible investment choices.