The European regulation of ESG rating agencies, which came into force on 2 July, marks an important step in the structuring of sustainable finance. By bringing ESG ratings under supervision, the regulator aims to strengthen investor confidence, improve the transparency of methodologies and reduce the risk of conflicts of interest. At first glance, however, the text appears to leave aside one central issue: ESG data itself.
That is precisely where the paradox lies. Agencies providing ESG ratings in the European market will now be supervised by ESMA, while providers of non-financial data will remain outside the scope of this oversight.
This asymmetry has fuelled considerable criticism: It could create a competitive distortion that weakens regulated players and undermines the proper functioning of the market by allowing information to circulate without any real transparency requirements. Should we therefore conclude that data will become the poor cousin in the sustainable finance family, a commodity bought at the lowest possible price? With ultimately damaging effects on the market’s ability to function properly?
Contrary to this pessimistic scenario, we believe instead that the market is entering a particularly interesting moment.
All is not lost
This regulation could actually have some positive side effects on data quality. Indeed, in order to meet the regulator’s transparency expectations and explain their ratings, agencies will now have to account for the sources of the underlying data, the nature of the data used, its collection and quality-control processes, as well as the models or algorithms applied when certain information, because it is unavailable, has to be estimated. In other words, even if data is not directly regulated, it will inevitably be brought into the spotlight.
Because data is the cornerstone of any rating, regulating ratings necessarily brings the underlying data under closer scrutiny. Given the vigilance of both investors and supervisors on these issues, the transparency imposed by the regulator is likely to encourage agencies to avoid leaving themselves open to criticism — and therefore to ensure a quality standard that can stand up to external scrutiny.
The regulation also provides that rated companies may flag possible factual errors before their rating is finalised, a mechanism that could further improve the accuracy of the underlying data used by rating agencies.
One decisive issue remains: Cost
In a market where pricing pressure is intensifying, the risk is that investors may end up trading off quality. This is where technological progress changes the equation. After several years of uneven experimentation, our teams are now seeing artificial intelligence (AI) reach a level of maturity that makes it possible to industrialise the collection and verification of non-financial data with a markedly higher degree of reliability.
This promise, however, holds true only on one condition: AI can produce relevant data only if it is backed by solid sustainable finance expertise – and more specifically by a deep understanding of governance, social and environmental issues – capable of answering questions such as: Which social practice can genuinely be considered ethical, or which impact indicator should be collected in the field of biodiversity? Such expertise is essential to redefine ESG indicators at a level of granularity and simplicity that enables AI to collect them with a reduced error rate. It is also crucial to ensuring quality control behind the tasks performed by AI.
The good news, then, is that the maturity of AI – and the ability of teams to harness it – is arriving at just the right time, making it possible to overcome the trade-off between quality, scalable coverage and competitiveness.
A historic opportunity for investors
Europe’s sustainable finance market is reaching an inflection point. As regulation and technology reshape the landscape, investors no longer have to compromise between data quality, global coverage and cost competitiveness. What were once difficult trade-offs can now be achieved simultaneously.
For European financial institutions, this represents a strategic opportunity: To strengthen Europe’s capacity in ESG data at a time of growing geopolitical uncertainty, by partnering with European providers that combine methodological rigor, deep sector expertise and advanced technology.
Regulation is reshaping the European sustainable finance landscape, prompting rating agencies to redefine their positioning. The next step is for financial institutions to support the development of a high-performing, competitive and strategically independent European ESG ecosystem.
Julia Haake, CRO at EthiFinance and Chair of the Board of EASRA
