Sustainable investing has evolved from a niche trend into a mass-market product. However, as the volume of money in green funds grows, so does the pressure to address a question that has long remained in the background: how do we actually know if an investment is truly sustainable? ESG ratings were supposed to provide the answer. Yet, the experience of recent years has shown that they are one of the weakest links in the entire system. The European Union is responding with a series of regulatory steps, the latest of which—direct supervision of ESG rating providers—came into effect on July 2, 2026.
The fundamental problem with ESG ratings was described in a study by MIT Sloan researchers Berg, Kölbel, and Rigobon, published under the telling title "Aggregate Confusion." The authors compared the ratings of six leading agencies and found that the average correlation between their ESG scores is only 0.54, ranging from 0.38 to 0.71. For comparison, credit ratings from S&P and Moody's correlate at a level exceeding 0.9. While the market generally agrees on credit risk, the same company can be rated as a top performer by one agency and below average by another when it comes to sustainability. A prime example is Tesla, which MSCI rated AA, while S&P Global gave it only BB.
The causes lie not primarily in errors, but in differing methodologies. Agencies differ in which areas they evaluate, how they measure them, and what weight they assign to them. Also crucial is the conceptual dispute over "double materiality": should a rating measure how sustainability-related risks threaten a company, or what impact the company has on society and the environment? Different agencies answer this differently, and investors are often left comparing the incomparable. It is estimated that over 4,600 entities providing ESG assessments have been operating in the market.
The risks associated with exaggerated sustainability claims are best illustrated by the case of the asset management firm DWS, part of the Deutsche Bank group. In 2021, its former head of sustainability, Desiree Fixler, claimed that the firm had presented investors with a significantly more favorable picture of its ESG activities than was the reality. This was followed by raids on the Frankfurt offices, the resignation of the CEO, and investigations on both sides of the Atlantic. In 2023, the U.S. SEC fined DWS $19 million for misleading claims about incorporating ESG factors into the investment process. In April 2025, the Frankfurt public prosecutor's office added a €25 million fine, stating that marketing claims about DWS being an "ESG leader" did not reflect actual practice.
The DWS case became a symbol of greenwashing in asset management and, at the same time, an impetus that accelerated the regulatory response.
The European Union is approaching the problem systematically, and its framework now rests on three pillars.
The first is the SFDR regulation, which has required funds to transparently declare their relationship to sustainability since 2021. The European Commission is currently working on a revision intended to introduce three clear product categories: Sustainable, Transition, and ESG basics. The goal is to replace the current technical division under Articles 8 and 9 with a system that even an average investor can understand. However, non-governmental organizations point out that the least strict category, ESG basics, will require careful definition to ensure it does not become a haven for products with significant fossil fuel exposure.
The second pillar consists of ESMA rules for fund names, effective from May 2025. A fund with sustainability-related terminology in its name must invest at least 80 percent of its assets in accordance with that name and apply exclusion criteria. ESMA data shows that the rules are working: approximately two-thirds of the affected funds have changed their names, usually by dropping ESG terminology, and more than half have tightened their investment policies, typically by adding fossil fuel exclusions. At the same time, however, there are attempts to circumvent the rules, for example by renaming funds with terms like "Screened," which the regulation does not cover. The regulatory framework will therefore need to continue to evolve.
The third and newest pillar is Regulation (EU) 2024/3005 on the transparency and integrity of ESG ratings, effective from July 2, 2026. With this, the EU has become the first jurisdiction in the world to formally regulate the ESG ratings market. Providers are now subject to authorization and direct supervision by ESMA, must disclose their methodologies and data sources, and are prohibited from combining ratings with consulting, credit ratings, or benchmark creation within the same entity to avoid conflicts of interest. The regulation intentionally does not unify methodologies: the diversity of perspectives on sustainability remains legitimate, but investors must be able to understand what a specific rating is measuring.
The European approach can be summarized simply: regulation does not prescribe what is sustainable, but it enforces that sustainability claims be substantiated and understandable. For investors and advisors, this leads to a practical recommendation. An ESG rating is a useful input, not a final verdict, and it is always worth knowing whose rating is being used and what it measures. For funds, it is crucial to look beyond the name, into the actual composition of the portfolio and the binding elements of the investment strategy.
The sustainable finance market is coming of age. Stricter rules mean higher costs and fewer "green" labeled products in the short term. In the long run, however, they are essential for ensuring that sustainable investing is built on trust rather than marketing.
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