Commission timeline comes too late to support SFDR Level 2 compliance, despite six-month delay.
A new European Commission timeline means that measures to improve the reliability, comparability and transparency of ESG ratings won’t be introduced until Q1 2023 “at the earliest”, according to Dominik Hatiar, Regulatory Policy Advisor for the European Fund and Asset Management Association (EFAMA).
The announcement was part of the Commission’s updated Sustainable Finance Strategy, which also included: new measures to boost access to transition finance; support for SMEs on sustainability reporting; a proposal for a European Green Bond Standard; and the formal adoption of a delegated act based on Article 8 of the Taxonomy Regulation.
The Commission is expected to organise a public consultation on potential regulatory measures for the ESG ratings market by Q4 2021. The consultation will then be subject to an impact assessment before the Commission can put forward a proposal.
“We believe the ESG ratings framework should align with the application of the full taxonomy disclosure obligations for financial undertakings under the newly adopted Taxonomy Article 8 delegated act,” Hatiar told ESG Investor.
The delegated act was formally adopted on 6 July, with financial institutions expected to report in line with Article 8 from 1 January, 2024.
This planned legislation builds on a study commissioned by the EC in January 2021, undertaken by the SustainAbility Institute, the thought leadership platform of multinational consultancy firm Environmental Resources Management (ERM).
“The main issues identified by asset managers and asset owners related to transparency in terms of ESG data and rating agency models and methodologies,” said Philip Stewart, Senior Partner at ERM.
The European Securities and Markets Authority (ESMA) also expressed its support for regulation, recommending that the Commission implements specific product requirements for ESG ratings agencies and data providers.
ESMA noted that these requirements shouldn’t be the same level of “prescriptiveness” as those applicable to credit ratings, but should be “sufficiently stringent to ensure that ESG ratings and assessments are based on up to date, reliable and transparent data sources, and developed according to robust methodologies that are transparent and open to challenge by investors”.
Regulatory action taken by the Commission should not stifle market innovation, said Hatiar. “The framework should be proportionate and flexible,” he noted.
The Commission should also make sure that regulation doesn’t favour larger providers over smaller providers, said ERM’s Stewart, recommending that regulation focuses on the disclosure of methodologies, rather than controlling approaches to data collation and measurement.
This would give investors more transparency and better isolate third-party vendors that may not be collating ESG-related data as accurately or reliably, Stewart explained.
Although the Commission has delayed Level 2 of the Sustainable Finance Disclosure Regulation (SFDR), the timing of related regulatory initiatives could still be viewed as less than optimal by regulated firms, notable asset managers.
Originally expected to apply from 1 January, 2022, it has been postponed until July.
The Commission cited the ongoing “length and technical detail” required before finalising the regulatory technical standards (RTSs) as the reason for this delay, according to law firm Simmons and Simmons. The RTSs require asset managers to augment their Level One green categorisations of their products with more detailed underlying data across a series of social and environmental factors.
Asset managers complying with SFDR would potentially benefit from more clarity and transparency from ESG ratings agencies and data providers, as this would better inform their own analysis of corporate ESG-related performance. But the delay to SFDR Level 2 still leaves a six-to-nine-month gap before the introduction of new rules for ESG ratings.
“While we would have welcomed an earlier timeline for a public consultation and an impact assessment on a possible legislative framework for ESG ratings, we appreciate the Commission’s commitment to fill this regulatory gap through comprehensive stakeholder involvement and an evidence-based assessment,” said Hatiar.
Hatiar has previously told ESG Investor that the Commission needs to ensure that all regulatory timelines for its sustainable agenda make sense for corporates and investors.
The case for regulating ESG ratings was previously made by the French and Dutch regulators for financial markets – the Autorité Des Marchés Financiers (AMF) and Autoriteit Financiële Markten (AFM). They published a joint paper outlining possible third-party data vendor standards in November last year.