The Sustainable Finance Beirat, the body advising the German government on its sustainable finance strategy, is recommending as a requirement that ESG rating providers disclose how they deal with conflicts of interest.

The committee is proposing to clearly separate organisational structures or processes of ESG rating providers, if they offer companies products or services for a fee, to avoid conflicts of interest, it said in a position paper on regulating ESG rating providers.

The group, which has drafted the paper in view of the legislative proposal by the European Commission on ESG ratings expected in mid-June, also considers essential the improvement of quality standards for rating methods, their transparency, the dialogue between ESG rating providers and companies, or other stakeholders, it added in the paper.

“ESG ratings are one of the most important elements to make financial decisions on sustainability. Companies, financial institutions and other stakeholders have to be sure that the analyses are of impeccable quality,” said Julia Haake, co-chair of the working group on ESG ratings regulation.

Under the new EU rules, possible conflicts of interest for ESG rating agencies may arise for consultancy services, the issuance and sale of credit ratings, or the development of benchmarks, Bloomberg reported citing a draft document of the upcoming regulation.

Meanwhile, the sustainable finance committee has conducted in-depth interviews with ESG rating providers including Imug, ISS ESG, MSCI, Sustainalytics and S&P between April and May to draft its position paper.

It has discussed to what extent the dominant “investor pays” model, meaning banks, investors and others financial institutions paying for ESG rating data, can be replaced by an “issuer pays” model, where rated companies pay for an ESG rating.

From the point of view of the ESG rating providers, an “issuer pays” model would be more profitable, with some providers offering appropriate solutions for interested companies.

The Beirat recommended that the upcoming regulation covers all providers of ESG ratings and scores selling their products and services in the EU, regardless of a company’s headquarters, or of the location of individual business units, or of the size of the provider.

The rules should also apply to providers of so-called “SPOs” (Second Party Opinions) for green/sustainable securities, the paper added.

The committee is also in favour of setting out minimum standards to source data, and minimum standards based on international frameworks, for example ILO labour standards, Paris Agreement, and have a scientific reference, for example Science Based Targets initiative (SBTi).

The Beirat is also pushing for rating providers to put in place internal processes to define and document the quality of their services, or if rating methods change, the frequency of ratings, and their dialogue with companies, it added.

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