ESG ratings get a scoreboard, not a floor

By 2 November, any ESG rating provider that wants to keep operating in the European Union must file with the European Securities and Markets Authority. The deadline is the first hard edge of a regime that ends two decades in which ESG ratings were sold into investment processes with no dedicated EU supervision; as Responsible Investor argues in a commentary published 26 August, it builds a scoreboard without yet setting a floor.

The regulation does real work before the first filing lands. It separates the ratings business from the sale of services to rated entities, removing the most corrosive conflict of interest in the market; it concentrates supervision in one authority rather than twenty-seven; and its Annex III disclosures give investors something they have not had—the ability to see whether two providers disagree because they used different data or because they weighted the same data differently.

The regulation leaves providers free on methodology itself, which the commentary argues is the right call. Much of what looks like methodological divergence is judgment, and judgment is exactly what investors are paying for; push two providers toward the same answer and the market ends up paying twice for a single opinion.

For an investor working through a fund prospectus or an index methodology, the practical effect, if the disclosures work as intended, is to turn the rating from a trusted number into an inspected variable. The question shifts from which provider is right to why two providers disagree, and whether the gap traces to data or to weights. That is the scoreboard half of the regime.

The regime's quality bet rests on one assumption: once conflicts are removed and methodologies published, competition will look after the rest. The commentary tests that assumption against the nearest neighbor an ESG rating has—green bond certification. The products differ—a verifier checks a bond against a label, a rater grades risk and impact—but the economics underneath match, because both sell expert judgment that buyers take on trust and both draw credibility from the reputation of the field as a whole.

The model, published this year, shows what that shared reputation does to standards: being strict is expensive for the certifier doing the checking, while the credibility from that strictness spreads across every rival, because investors judge certifiers as a group. Each firm carries the full cost of rigour and captures only a fraction of the reward, so each relaxes its standard, and competition accelerates the decline.

The model's numbers are stark: two competing certifiers settle at just over half the standard a single certifier would maintain, five at a quarter of it, and a lower standard means the label extends to weaker projects. None of this requires bad actors—the certifiers in the model are honest, fully independent and free of conflicts—yet standards still slide, because shared reputation alone is enough.

The comparison to green bonds is not exact, and the commentary does not pretend otherwise: a verifier checks a bond against a fixed label, while a rater grades risk, impact or both. But the feature the model isolates—a field's reputation as a common good that every firm draws on and no firm is paid to maintain—is present in ESG ratings too. The model's parameters are stylized, but the mechanism does not depend on them being precisely right; it depends on the cost of rigour being private and the benefit being public, and that is the shape of the ratings market as well.

For the EU regime, this is the uncomfortable part. The conflict-of-interest rules solve the problem everyone could see; the erosion in the model is a different problem, and it survives those rules. The shape of the market makes the point concrete: ESMA's notification list, published in July, already names Sustainalytics, MSCI, Sustainable Fitch, Clarity AI and EthiFinance, among others. That is a crowded field, and in the model crowding is exactly what dilutes the reward for strictness. If the model transfers, the more providers that file by 2 November, the faster the floor sinks.

The commentary's title—'ESG ratings need both a scoreboard and a floor'—captures the asymmetry. The regulation and its Annex III disclosures build the scoreboard; what the regime lacks is a floor. Leaving methodology free is defensible, and the disclosure work is genuinely new. The assumption that competition polices quality is the vulnerable piece, and the green bond math puts a number on exactly how vulnerable.

None of this argues for regulating methodology, which would produce the worst outcome: providers converging on a single opinion while investors pay twice for it. It argues for watching the ratings themselves after 2 November. The thing to watch is not the filing queue but the distribution of ratings once it clears—whether providers compete on disclosure, price and service, or on leniency. The green bond model says the pressure points that way. That is the case for treating the floor as a supervisory problem now, rather than discovering later that competition had the same effect here that it had in certification.