By Julia Payne and Tommy Wilkes
BRUSSELS/LONDON (Reuters) - The European Union on Tuesday proposed new regulations for firms selling environmental, social and governance (ESG) ratings that could force some to restructure their businesses in a major shake-up of the industry.
S&P Global, Moody's, MSCI> and Morningstar's Sustainalytics are among the biggest sellers of ratings on companies' ESG performance that help guide trillions of investment dollars.
According to the EU's draft legislation, providers must stop providing consulting services to investors, the sale of credit ratings and the development of benchmarks among other things, to avoid potential conflicts of interest.
Providers will need to be authorised and supervised by the European Securities and Markets Authority (ESMA), and breaching the new rules could land them with a fine of up to 10% of their annual net turnover.
The rules could force agencies to separate their businesses, although it was not immediately clear what changes companies would need to make to be regarded as operating independently.
"ESG ratings agencies that score companies on governance factors are completely unregulated so it's very difficult to compare ratings by different agencies. We have no clarity on how these ratings are reached and there appears to be conflict of interests," Mairead McGuinness, European Commissioner for Financial Services, told reporters.
"We want them (ratings) to be reliable and comparable."
Critics say ESG ratings methodologies are overly complex, opaque and tend to reward companies that disclose more information, rather than those that are best able to manage ESG risks or do the best job in limiting negative business impacts on the planet.
Authorities are trying to incentivise more sustainable investment and tackle greenwashing by boosting transparency and arming investors with better information. Britain this year also outlined plans to regulate ESG ratings providers.
MSCI ESG Research, one of the biggest players in the market, said in a statement it was assessing the implications for its business and products and that it maintained a "culture of independence and transparency" in providing ratings.
S&P Global said it believed "consistent implementation" of the recommendations from IOSCO, the global securities regulatory body, would support ESG ratings products and help avoid fragmentation across jurisdictions.
The London Stock Exchange Group (LON:LSEG), which also provides ratings through its Refinitiv unit, said it welcomed the EU's proposed rules. Thomson Reuters, the parent company of Reuters, owns a stake in LSEG.
"The proposal introduces greater transparency in the market, without prescribing ESG assessment methodologies, contributing to more effective allocation of capital to sustainable investment activities," it said.
Morningstar Sustainalytics said its analysts were reviewing the proposal to understand the broader industry implications.
Moody's did not respond to a request for comment.
POORLY UNDERSTOOD
ESG ratings measure a company's exposure to financially relevant ESG factors like pollution or human rights and then how the firm is managing exposure to such risks.
Typically, the ratings do not measure a company's impact on the environment and the outside world, and the relatively high ranking awarded to fossil fuel or mining companies has prompted criticism that end-investors do not understand how they work.
Global sustainable assets under management stood at $2.74 trillion in March, Morningstar estimates. Much of that is in funds which track indexes comprised of companies awarded certain ESG rankings, or which exclude those firms ranked lowly.
Markus Ferber, a German Conservative European parliamentarian, criticised the EU's proposals on Tuesday.
"Allowing only stand-alone ESG rating providers significantly limits the pool of companies that can provide such a service in the first place ... There is a big risk that the end result will simply be fewer ESG ratings in Europe," Ferber said in an emailed statement.
The European Commission announced its plan as part of new measures unveiled on Tuesday to encourage more ethical and sustainable investment.
These included new criteria for its so-called taxonomy, a system that classifies which parts of the economy can be marketed as sustainable investments.