By Christopher Walker

On 29 January, the European Securities and Markets Authority (“ESMA”) published a letter sent to the European Commission (“EC”) regarding the current issues it sees in respect of environmental, social and governance (ESG) ratings and assessment tools – which ESMA describes as an “unregulated and unsupervised” market – in light of the increasing global demand for ESG information relating to financial products

The current position means that risks exist in relation to the greenwashing of financial products, consumer confusion over what “ESG” means and potential capital misallocation considerations which could affect the transition towards a “more sustainable financial system”.

Therefore, ESMA has suggested a future legal framework which takes into account the following:

• Scale: ESMA suggests that any future framework would need to accommodate large multinational ESG ratings providers who may already be subject to existing regulatory frameworks and smaller entities to whom compliance is both less familiar and potentially more difficult to handle in resource terms (i.e. the relevant requirements would have to be proportionate to the size of the entity concerned);
• Standardisation: ESMA notes that unlike credit ratings, currently “ESG ratings display very low levels of correlation across providers, leading to issues down the investment value chain” – so it suggests “a common legal definition should be developed for an ESG rating that captures the broad spectrum of assessment tools that are currently available in the market”. ESMA recognises that any new definitions in this area will need to be consistent with other areas of EU regulation, such as the Sustainable Finance Taxonomy Regulation.
• Supervision: unsurprisingly, ESMA notes that any “legal entity whose occupation includes the issuing of these ESG ratings and assessments should be required to be registered and supervised by a public authority” – ESMA suggests that it is a suitable body to perform such role, given its existing mandate for Credit Ratings Agencies;
• Suitable precedents: ESMA suggests that the CRA Regulation might be a helpful starting point in developing any new European legal framework.

ESMA’s prior response to the EC in respect of the Renewed Sustainable Finance Strategy can be viewed here.

The European Supervisory Authorities’ ongoing development of new ESG frameworks will remain an interest to the UK’s financial regulatory regime – detailed policy proposals for asset managers, life insurers and FCA-regulated pension schemes are currently expected in H1 2021 via an FCA consultation paper.