The European Union (“EU”) set out an ambitious policy agenda to reduce its impact on climate change. Although the popular image is that economic growth and sustainability are practically incompatible, this policy agenda includes measures enabling reallocation of investment towards sustainable projects and companies. This paper posits that, by adopting measures requiring the disclosure of non-financial and in particular Environmental, Social, and Governance (“ESG”) information, EU policy relies on market efficiency to ensure the desired reallocation of investment.

The role of ESG rating agencies

In order for this market efficiency approach to work properly, non-financial information must be accessible, comparable, and verified. This creates a new role for (non-financial) information verifiers, such as ESG Rating Agencies. Their role, as observed with Credit Rating Agencies, thus becomes twofold: reducing the non-financial information asymmetry and performing an almost regulatory function on sustainability. This paper examines the impact of ESG Rating Agencies, suggesting that methodologies differ widely although industry consolidation has improved uniformity. Furthermore, the combined measurement of ‘E’, ‘S’, and ‘G’ could lead to decent overall ratings but with poor scores for ‘E’.

This paper concludes that increased oversight and regulation of ESG Rating Agencies may be required to ensure they fulfill their role in enabling this market-based approach towards tackling climate change.