Earlier this week, the European Parliament and Council reached a historic provisional agreement on legislation focused on enhancing transparency and public oversight of ESG rating agencies.
ESG stands for Environmental, Social and Governance. These ratings are used to measure how companies and financial products are doing in terms of being good for the environment and society, and also how well they are managed.
This might seem positive on the surface, but the problem is that the market for ESG ratings has grown too fast, without careful and credible regulation. We addressed this issue last year in our report ’How to Stop the Wild Green Gold Rush: Credible ESG Ratings’.
We highlighted clearly that ESG ratings were suffering from many problems, such as a dependence on large and oligopolistic credit rating agencies, and a lack of standards, accuracy and transparency. This is why the agreement reached is such a meaningful step to improve the integrity of ESG rating providers and, last but not least, to help people have a better understanding of how they work and how to use them to identify ’bad’ and ’good’ companies.
As pointed out by the MEPs who brought this proposal forward, and as we also pointed out in our study, ESG rating agencies suffer from a lack of transparency and standardisation, significant biases, and conflicts of interest. It’s hard to say how these ratings are calculated, given their opaque methodologies, making it difficult to trust them. Greenwashing was also a concern, as companies could get good ratings even if they were not actually doing much good for the environment or society.
A significant accomplishment of the agreement reached this week is the mandate for rating agencies to ’disaggregate’ environmental, social and governance criteria into distinct components. Specifically, the agreement foresees that agencies must either provide separate ratings for environmental, social or governance aspects, or if a unified score is provided, explain the weight of these three different individual components.
The new rules are a significant step forward for people to have the right to access clear information about companies and to make ESG ratings more reliable, clear and unbiased. This would help ensure that investments are really helping to tackle climate change and benefit society, rather than just making some people richer!