Norges Bank Investment Management (NBIM) has provided feedback to the European Commission’s legislative proposal for a regulation on the transparency and integrity of ESG rating activities.

The proposal for new rules for ESG rating providers was part of a new package of measures announced by the commission in June, which aim to build on and strengthen the foundation of the EU sustainable finance framework.

In its feedback, NBIM, which is responsible for the investments of the Government Pension Fund Global in Norway, said it concurred with the European Commission’s assessment that the ESG rating market suffers from deficiencies that could undermine investors’ and rated entities’ confidence in ratings.

“We welcome the commission’s intention to improve the transparency on the characteristics of ESG ratings, their methodologies and data sources. Increased transparency on ESG ratings can enhance pricing efficiency and the well-functioning of markets,” NBIM stated.

“This can contribute to a higher degree of confidence in the use of these products within financial markets, benefiting investors while also enhancing market integrity, risk pricing, and capital allocation.”

It noted that the low correlation between ESG ratings issued by different ratings providers was not surprising, due to the diversity in assumptions, objectives and methodological approaches they employ.

While NBIM agreed with the commission's intention not to try and standardise ESG ratings output, it said that the approach taken by providers might not always be transparent, which can cause ESG ratings to be misinterpreted and misapplied.

The investment manager therefore welcomed the proposed requirements for ESG ratings providers to disclose information on methodologies, models, and key rating assumptions.

“Regarding changes to rating methodologies, we believe that transparency on the methodology update policy and approach to historical ratings could be more suitable than an obligation to review methodologies at least annually,” NBIM added.

“A mandatory annual update might not be the appropriate frequency for every rating approach, and could potentially lead to decreased comparability of ratings.

“We suggest instead that the disclosure requirement on changes to the rating methodology is enhanced to enable users to understand the impact that methodology changes can have.

“We also support the overarching obligation for ESG rating providers to ensure that the information used is of sufficient quality and from reliable sources.”

Furthermore, NBIM believed that ESG rating providers should have policies and procedures in place to manage conflicts of interest, and therefore supported requirements on independence and avoidance of conflicts.

However, it urged the commission to consider requiring the conflicts of interest to also be disclosed to users of ESG ratings, not just to ESMA.

NBIM also highlighted a potential inconsistency on requiring ESG providers to provide information on “whether and how the methodologies are based on scientific evidence” and another requirement in the legislative proposal that meant providers had to explicitly mention that their ESG ratings are opinions.

Furthermore, NBIM called for clarity on the intention behind the requirement to disclose which metrics have been selected as relevant, as part of the more granular overview of methodologies to be provided to users and rated entities.

“Finally, the market for ESG ratings is global and many providers operate across borders,” NBIM said.

“We welcome the work on ESG ratings and data products providers undertaken by the International Organisation of Securities Commissions (IOSCO) and its recommendations from November 2021, and support the global harmonisation of regulatory regimes for ESG rating providers.

“We therefore support the decision by the European Commission to align the definition of ESG ratings with the one provided by IOSCO, and importantly the role played by the third country’s compliance with the IOSCO recommendations in the commission’s equivalence and endorsement framework for third country ESG rating providers.”

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