5.6.2 Could the regulation of sustainability rating agencies be similar to the regulation of the credit rating agencies?

Without making qualitative judgments to the content and purpose of the regulation of credit rating agencies, my purpose is to use it as an example of an approach to regulate a controversial and challenging topic within the capital markets. The regulation of credit rating agencies although disperse has become better rounded, more transparent and stricter.1

The European Commission regulates credit rating agencies.2 This regulation followed the G20 commitments at the Washington Summit in November 2008. The European Commission regulates the activity of the credit rating agencies to protect “investors and European financial markets against the risk of malpractice, and to guarantee the independence and integrity of the credit rating process and to improve the quality of the ratings issued.” Since July 2011, the European Securities and Markets Authority is the single direct supervisor of credit rating agencies within the EU. The European Securities and Markets Authority has exclusive supervisory powers over the credit rating agencies’ activities.3

Recently in December 2018, following on the recent EU Action Plan of 2018, the European Securities and Markets Authority (ESMA) launched a consultation paper, proposing credit rating agencies to be required in the future to disclose whether and how ESG criteria have been considered as part of a credit assessment outlook.4 This is based on the fact that companies are increasingly integrating ESG risks in their annual reports and also on the fact that non-financial information becomes more quantifiable. With increased integration of non-financial information in annual reports, credit rating agencies may be required to include ESG criteria in their credit assessment.

The purpose of credit rating agencies is to analyze the creditworthiness of a company, its debt capacity. The credit rating agencies do this on a short term, usually on a three to five years span.5 The essence of analyzing corporate debt capacity on a short term is fundamentally different from analyzing corporate long- term ESG risks. Both credit and sustainability ratings are essential to the future of healthy and sustainable capital markets. However, only credit ratings are subject to regulatory supervision. ESG risks are increasingly brought to the attention of credit rating agencies but not yet embedded in their methodologies. Credit rating agencies’ failures are unfortunately well known, and reminded during the financial crisis in 2008.

Currently, more than 100 sustainability raters are not regulated and their activity is not monitored by any national or international institution. Contrary to credit rating agencies, sustainability raters are not accredited by any Governmental or independent third party institution. The Global Initiative for Sustainability Ratings (GISR) is working to become the rater of the sustainability raters.6

Regulation of sustainability ratings is an idea worth exploring, whether by requiring ESG considerations into the scope of credit ratings or by developing a parallel “rigorous, usable and responsive” sustainability rating system (Allen L White, 2014).7 As mentioned above (sections 3 b) and 6.1), regulation would level the playing field by establishing minimum sustainability ratings’ standards. As explained above, credit ratings are fundamentally different from sustainability ratings therefore, both need legislation tailored to their needs. However, looking at the way that credit rating agencies are currently regulated may be a start for developing legislation on sustainability ratings.