By Julia Payne and Tommy Wilkes
BRUSSELS/LONDON (Reuters) -The European Union is to regulate agencies providing environmental, social and governance (ESG) ratings in an effort to improve standards in an industry that guides trillions of dollars of investments.
ESG ratings providers must stop providing consulting services to investors, stop the sale of credit ratings and the development of benchmarks among other things, according to the EU’s draft legislation published on Tuesday.
Providers will need to be authorised and supervised by the European Securities and Markets Authority (ESMA), and breaching the new rules could land them with a fine of up to 10% of their annual net turnover.
“ESG ratings agencies that score companies on governance factors are completely unregulated so it’s very difficult to compare ratings by different agencies. We have no clarity on how these ratings are reached and there appears to be conflict of interests,” Mairead McGuinness, European Commissioner for Financial Services, told reporters on Tuesday.
“We want them (ratings) to be reliable and comparable.”
Investors are increasingly buying stocks and bonds according to how companies rank on various ESG metrics, and the ratings industry is growing fast as demand for investment products packaged and marketed as meeting ESG criteria balloons.
Critics say ESG ratings methodologies are overly complex, opaque and tend to reward companies that disclose more information, rather than those that are best able to manage ESG risks or do the best job in limiting their negative impact.
Agencies providing ESG ratings include S&P Global, Moody’s, MSCI> and Morningstar’s Sustainalytics.
The companies are yet to respond to requests for comment.
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ESG ratings measure a company’s exposure to financially relevant ESG factors like pollution or human rights and then how the firm is managing exposure to such risks.
Typically, the ratings do not measure a company’s impact on the environment and the outside world, and the relatively high ranking awarded to fossil fuel or mining companies has prompted criticism that end-investors do not understand how they work.
Britain has also outlined plans to regulate ESG ratings providers where the rating is used by anyone in the UK.
In March, the finance ministry published a consultation on regulating ESG ratings providers, saying it saw a “clear benefit” from improving the transparency of methodologies as well as rating providers’ governance and processes.
Global sustainable assets under management stood at $2.74 trillion in March, Morningstar estimates. Much of that is in funds which track indexes comprised of companies awarded certain ESG rankings.
Markus Ferber, a German Conservative European parliamentarian, criticised the EU’s proposals on Tuesday.
“Allowing only stand-alone ESG rating providers significantly limits the pool of companies that can provide such a service in the first place…There is a big risk that the end result will simply be fewer ESG ratings in Europe,” Ferber said in an emailed statement.
The European Commission announced its plan as part of new measures unveiled on Tuesday to encourage more ethical and sustainable investment. This included new criteria for its so-called taxonomy, a classification system for which parts of the economy can be marketed as sustainable investments.
(Reporting by Julia Payne and Tommy Reggiori Wilkes,Editing by Sinead Cruise, Mark Potter and Ed Osmond)
