The European Securities and Markets Authority recently wrote to Mairéad McGuinness MEP as European Commissioner for Financial Stability, Financial Services and Capital Markets Union to highlight issues relating to data quality and the absence of supervisory control of ESG ratings. ESMA noted, amongst other things that:

  • providers of ESG ratings and other assessment tools are not currently required to be supervised;
  • there can be a lack of transparency in relation to the methodologies used to formulate ESG ratings; and
  • there can be low level of correlation between the ESG ratings provided by different providers to the same issuers and/or securities relative to credit ratings.

These comments underline ongoing concerns that the current growth in sustainable finance products could result in "greenwashing" whereby securities or funds may be misleadingly branded as ESG- or sustainability-focused.

While noting the substantial progress made by the European Commission in the field of sustainable finance, ESMA has made several recommendations, such as proposing that:

  • there should be a common definition for an ESG rating which covers the universe of possible ESG assessments which are currently on offer; and 
  • entities which issue ESG ratings falling within this definition should be registered and supervised by a public authority. 

If implemented, this would be a welcome development in relation to regulated investment products which incorporate ESG ratings.

Sustainable finance in private markets

The scope of sustainable finance also incorporates private/unregulated products such as green or sustainability-linked loans, where borrowers may determine their own "bespoke" sustainability performance targets by reference to targets which they determine as material to their business and stakeholders. The nature of these sustainable performance targets means that there is also scope to improve transparency and oversight.

Guidance from the Loan Market Association ("LMA") and other industry bodies has noted that sustainable performance targets must be meaningful and ambitious rather than being capable of being met simply through "business as usual" performance and should be subject to third party verification.

As sustainability-linked loans become more common for broadly syndicated financing transactions (sustainability-linked leveraged loan deals have recently been issued by companies such as MasMovil (telecoms), Flender (turbine supplier) and Kersia (food safety)), there is likely to be further focus from industry bodies such as the LMA and the European Leveraged Finance Association on the form/content of ESG-specific contractual provisions which should be included in loan documentation, such as ongoing information undertakings as to performance against ESG metrics, forms of ESG compliance certificates; and representations and undertakings as to the implementation of the borrower group’s internal policies and procedures.