ESG Ratings Get a Makeover: What the New EU Regulation Means for the Future of Sustainability!
By: Dori Felber
Reading time: 3 minutes and 22 seconds
Have you ever wondered whether companies are held to specific standards regarding their operations and their impact on stakeholders, the environment, and society? Look no further! On 12 December 2024, Regulation 2024/3005 on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities was published in the Official Journal of the EU.
The new Regulation introduces a comprehensive framework for ESG ratings, with its main objective being to improve the transparency and comparability of ESG assessments among rating providers. It aims to do this by establishing a strict set of criteria, and enforcing mandatory disclosure requirements under the supervision of European Securities and Markets Authorities (ESMA). Additionally, Regulation 2024/3005 amends the Sustainable Finance Disclosure Regulation (SFDR) by including a provision that expands online disclosure requirements for market players and financial advisors that issue and exchange ESG ratings with third parties.
The scope of Regulation 2024/3005 is quite limited, meaning a substantial amount of undertakings and activities are left out of its prescriptions (as specified in Article 2 (2)). Article 2 (1) details that the Regulation applies to ESG rating providers which operate in the EU, and lays out two scenarios. Firstly, the scope encompasses ESG rating providers that are established in the EU when they issue and publish their ESG ratings on their website or through other means. Equally, the Regulation applies to those who provide and distribute ESG ratings through subscriptions or contracts to financial institutions regulated in the EU, to businesses covered by Directive 2013/34/EU or Directive 2004/109/EC, and to EU institutions, agencies, or public authorities in Member States. Furthermore, Regulation 2024/3005 extends to ESG rating providers located outside the EU if they issue and distribute their ratings under similar arrangements to the same groups within the EU.
An important element of the Regulation 2024/3005 is that it offers a thorough legal definition of key terms ensuring precise and unambiguous interpretation within its provisions. Here are the key definitions of paramount importance within the binding legislative act:
‘ESG rating’ means an opinion or a score, or a combination of both, regarding a rated item’s profile or characteristics with regard to environmental, social and human rights, or governance factors, or regarding a rated item’s exposure to risks or impact on environmental, social and human rights, or governance factors, that is based on both an established methodology and a defined ranking system of rating categories, irrespective of whether such ESG rating is labelled as ‘ESG rating’, ‘ESG opinion’ or ‘ESG score’ (Article 3 (1));
‘ESG opinion’ means an ESG assessment that is based on a rule-based methodology and defined ranking system of rating categories, involving directly a rating analyst in the rating process ((Article 3 (2));
‘ESG score’ means an ESG measure derived from data, using a rule-based methodology, and based only on a pre-established statistical or algorithmic system or model, without any additional substantial analytical input from a rating analyst (Article 3 (3));
‘ESG rating provider’ means a legal person whose activities include the issuance, and the publication or distribution, of ESG ratings on a professional basis (Article 3 (4)).
Finally, a fundamental effect of the Regulation is the revision of Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services industry, also known as the SFDR. Specifically, it amends Article 13 of the SFDR to require financial market players to display the information indicated in point 1 of Annex III on their websites if they reveal an ESG rating to third parties as part of their marketing activities. Examples of the above-mentioned information that is required by such players to be displayed on their websites are, but not limited to:
The methodologies used;
The relevant industry classification;
Data sources and processes;
The limitations of methodologies and data sources;
Objective of rating;
The scope (E, S, or G factors; if all, then also including the weighting of each factor).
What’s next? The Regulation entered into force 20 days after its publication in the Official Journal of the European Union (1 January 2025), and shall apply from 2 July 2026.
ESG rating providers that functioned in the Union on the date of this Regulation's entry into force (2 January, 2025) must notify ESMA by 2 August, 2026, if they desire to continue functioning in the Union and apply for authorisation or recognition in line with the Regulation.
ESG rating providers who desire to continue functioning in the Union must apply for authorisation or recognition within four months of 2 July, 2026 (i.e., 2 November, 2026); otherwise, they must discontinue operations.
ESG rating providers classified as "small ESG rating providers" that operated in the Union at the date of entry into force of this Regulation (i.e., 2 January 2025) must notify ESMA no later than 2 November 2026 if they wish to continue operating in the Union; otherwise, they must cease their activities.
