EU ESG rating regulation falls short of double materiality standard, IEEFA warns

The European Commission's June 2023 proposal to regulate ESG rating activities does not explicitly uphold the principle of double materiality, a core pillar of the EU's broader sustainable finance framework. IEEFA has submitted a formal response identifying gaps between the proposed regulation and existing EU regulatory regimes, including the EU Taxonomy and disclosure requirements.

Released in June 2023, the European Commission's draft regulation on the transparency and integrity of ESG rating activities introduces new rules on organisational structure, processes and conflicts of interest. While IEEFA acknowledges the proposal as a breakthrough given the long-standing lack of oversight in the ESG ratings industry, it identifies a fundamental incoherence: the regulation does not align explicitly with the three pillars of the EU sustainable finance framework — the EU Taxonomy, disclosure regime and investment tools — and omits a clear commitment to double materiality, the principle that companies must report both their impact on society and society's impact on them.

IEEFA's submission argues that without coherence with the broader sustainable finance architecture, the regulation's effectiveness in addressing shortcomings in ESG rating activities will be limited, reducing its contribution to European Green Deal objectives. The institute also raises concerns that disclosure requirements under the draft regulation apply only to direct subscribers of ESG ratings rather than the public, creating information asymmetry and limiting transparency for end users and other stakeholders who rely on ratings without being direct clients of rating providers.

IEEFA recommends several improvements, including mandatory public disclosure of rating providers' legal structures and ownership, general compensation arrangements and methodologies applied when data is insufficient. Additional recommendations call for follow-up actions in related EU regulatory regimes to build a coherent and technically rigorous sustainable finance framework. The institute contends that a high-standard, comprehensive EU approach would enable the bloc to exercise global leadership on sustainable finance governance as regulators in other jurisdictions develop their own ESG oversight frameworks.

Key figure — June 2023 — date the European Commission released the ESG ratings regulation proposal