Since 2022, there has been a growing emphasis on strengthening the regulation of ESG rating agencies, and over the past year, related proposals and regulations have further taken shape. We believe that 2024 will be a key window for assessing compliance requirements and enhancing regulatory readiness in the ESG rating and data services sector.
In December 2023, the European Council reached a consensus on regulating ESG rating agencies. In its proposal, the European Council stated that ESG rating agencies operating in the EU should obtain authorization from the European Securities and Markets Authority (ESMA), while agencies headquartered outside the EU should receive endorsement from an equivalent functional regulatory authority.
It is worth noting that six months earlier, another key EU institution, the European Commission, had released a similar proposal that included several contentious requirements. For example, ESG rating agencies were required to disclose the basis for their pricing, such as the input of data analysts and IT resources. For non-compliant pricing practices, EU regulators would have the authority to impose fines.
Many industry institutions have expressed opposition to these requirements. MSCI stated that the EU's demands were highly unusual and argued that requiring the disclosure of pricing bases for rating products was overly intrusive. RepRisk, on the other hand, argued that early-stage operating costs are high for startups, and cost-based pricing requirements would cause them to lose competitiveness. Under such conditions, companies would be less willing to explore innovation and reduce costs.
Furthermore, the European Commission proposed requirements to avoid conflicts of interest, stipulating that agencies providing ESG ratings should not simultaneously offer ESG consulting services.
However, the European Council's proposal, issued in December, had a different perspective on this point. The Council believed that institutions could provide both ESG ratings and ESG consulting services, provided that there is a clear boundary between the two business areas and that measures are taken to avoid conflicts of interest. The European Council also suggested allowing a three-year grace period for small-scale agencies, with lighter regulatory requirements during this period.
It is reported that the European Commission and the European Council will soon begin negotiations on this issue.
The Monetary Authority of Singapore (MAS) recently concluded a consultation and released a Code of Conduct for ESG Rating Agencies. The Code mainly focuses on whether rating agencies have enough professionals and resources to ensure reliable ESG ratings and requires the use of an open and transparent methodology. However, the guidelines also include specific requirements, such as maintaining all rating records for at least six years from the date of rating issuance, and ensuring that fees charged for ESG ratings upon request are not tied to the rating outcome. Previously, the Hong Kong Securities and Futures Commission (SFC) also announced the formation of an industry-led working group responsible for developing a code of conduct for ESG rating and data products.
Hong Kong SFC
Currently, regulation for such agencies is mainly divided into two forms. Singapore's approach is similar to that of Japan and the United Kingdom, where codes of conduct are issued for agencies to voluntarily adopt, whereas the EU plans to initiate mandatory regulation.
Although strengthening the regulation of ESG rating agencies aligns with the needs of global sustainable investment development, there are concerns about whether the different regulatory approaches are appropriate.
In November 2023, Sustainalytics, a subsidiary of Morningstar that specializes in sustainability data and ratings, announced that it would stop providing ESG data and rating products to users in India starting December 1. Unlike the EU or Japan's emphasis on promoting open and transparent operations, India's regulatory requirements include the integration of specific metrics relevant to the Indian market, such as the number of jobs created in small towns and corporate social responsibility spending.