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ESMA advises against explicit ESG analysis mandate for credit rating agencies

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Credit rating agencies should not be explicitly required to consider environmental, social and corporate governance (ESG) factors when assessing issuers’ creditworthiness, according to the EU financial markets watchdog.

Amending the EU regulation governing credit rating agencies (CRAs) in this way would be “inadvisable” because of the specific role credit ratings continued to play within the financial system, said the European Securities and Markets Authority (ESMA), noting that key pieces of sectoral legislation still contained mechanistic references to credit ratings.

However, the EU supervisory authority said it could be useful to amend the regulation governing CRAs to provide a more consistent level of transparency around how they considered ESG factors in their credit assessments, and ensure the CRA regulatory framework kept pace with ESG developments in other areas.

ESMA also suggested that the European Commission could assess whether there were sufficient regulatory safeguards in place for products and entrants into the market that were likely to emerge from the EU executive’s ESG push.

Steven Maijoor, chair of ESMA, said: “Climate change is a reality. Financial market regulation needs to reflect this by integrating sustainability considerations.

Steven Maijoor, chair, ESMA

Source: ESMA

“Climate change is a reality. Financial market regulation needs to reflect this by integrating sustainability considerations”

Steven Maijoor, ESMA

“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 year, in the context of its sustainable finance action plan, the Commission charged ESMA with assessing current practice within the credit rating market concerning sustainability considerations.

The watchdog appears to have effectively rejected this task, however, saying in its report to the Commission that credit ratings were not sustainability assessments and that it was therefore “not possible to assess the practice of sustainability considerations in a market that is not measuring sustainability characteristics”.

In addition, the consideration of ESG factors as part of a credit rating “does not infer that the credit rating can be construed as providing an opinion on the sustainability or otherwise of an issuer or entity”.

ESMA had instead focused on what was possible to assess, it said, namely the extent to which “factors that are classified as either environmental, social or governance factors are considered within CRAs’ credit assessments”.

It found that CRAs were considering ESG factors in their ratings but that the prevalence and frequency of this depended on the agencies’ methodology.

In addition to releasing its technical advice to the Commission, ESMA published its final guidelines on disclosure requirements for CRAs, which it said should “improve the transparency of CRAs’ consideration of ESG factors in their credit rating press releases and reports”.

“This will allow the users of ratings to better assess where ESG factors are affecting credit rating actions,” said ESMA.

The Principles for Responsible Investment has been working on an initiative to enhance the transparent and systematic integration of ESG factors in credit risk analysis.

Carmen Nuzzo, the organisation’s head of fixed income, said ESMA was right to recommend not to amend CRA regulations to mandate the consideration of sustainability because CRAs had to include ESG factors in their credit rating opinions only when they were material to what the agencies measured, namely credit risk.

“Having said this, it is important that CRAs systematically include these factors and signpost clearly when these are relevant and contribute to their assessments,” she added. “ESMA’s conclusion to assess whether there are sufficient regulatory safeguards in place for other sustainability-dedicated products is also important, as at the moment these products are not regulated and their methodology is not very transparent.”

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