ESMA pulls back from ESG legislation for rating agency methodology

ESMA pulls back from ESG legislation for rating agency methodology

On July 18, the European Securities and Markets Authority published technical advice to the European Commission outlining its reluctance to compel these firms to include ESG factors in their analysis, preferring to issue guidelines for them to follow.

Credit rating agencies will not be forced to consider environmental, social and governance issues in their reports on companies, following a European securities regulator announcement.

ESMA said it had “assessed the level of consideration of ESG factors in both specific credit rating actions, and the credit rating market in general”, but found that, while credit rating agencies were taking ESG factors into account in their ratings, each would consider them differently according to asset class and general methodology.

It asked the European Commission to assess whether sufficient regulatory safeguards were currently in place for other products that will meet the demand for pure sustainability assessments.

Steven Maijoor, chair of ESMA said: “We have… issued guidelines to CRAs to ensure greater transparency around where ESG factors are considered in CRAs’ credit assessments.”

This should enable investors to immediately see if a down or upgrade had been forced by an ESG issue.

The announcement follows a consultation period run by the regulator, during which the European Association of Credit Rating Agencies (EACRA) pushed back against any legislative action being taken.

The move is one of several carried out across the European Union, alongside the European Commission’s Sustainable Finance plan.

The response from EACRA, published on its website, acknowledged “the rising interest towards sustainable finance topics in recent years” and noted the European Commission’s plan for financial markets to achieve it.

However, regarding changes to its own remit, it said: “While we believe that all financial market participants will in the long run include ESG considerations in their activities, we believe that currently not enough information is available to do this systematically.”

The association noted that its members were “closely following the topic”, with some introducing special products, others presenting ESG considerations separately, while others were doing relatively little.

Finally, EACRA said that to compel agencies to include ESG factors in their ratings would go against Article 23 of CRA Regulation on “non-interference with content of ratings or methodologies”.

This, EACRA said, meant ESMA was not permitted to dictate ESG inclusion in agencies’ methodologies, but leave it to each company to decide how they would approach the issue.

“From a technical perspective, ESG topics relate to a very long time horizon while ratings look to a period of three to five years,” EACRA said. “Given this mis-match in timing, an ESG topic is likely not to be the single factor driving a rating action but only one explaining element along several other factors. Singling out ESG factors on a systematic basis may result in overstating this aspect.”

On this point, ESMA said it would be “inadvisable” to amend the regulations to compel agencies to consider sustainability characteristics in their assessments, flagging the “specific role that credit ratings have in the EU regulatory framework for the purposes of assessing credit risk”.

However, ESMA has stepped in, to some extent, with its guidelines for agencies to follow.

But rather than instruct on agencies’ methodology, the guidelines focus on the impact of ESG factors on any changes in rating and how these factors were applied to the company and its peers.

Maijoor said: “Climate change is a reality. Financial market regulation needs to reflect this by integrating sustainability considerations. To support the European Commission in this area we have advised on the level of sustainability considerations in the credit rating market, indicating that as demand for sustainability assessments increases, so does the need for vigilance on the levels of investor protection.”

Last Updated: 26 July 2019
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