Thank you for summarizing the concerns of many. The shortcomings of the current ESG rating systems need to be addressed. The regulatory and legislative effort underway in Europe (e.g EU Sustainable Finance Strategy, https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/210706-sustainable-finance-strategy-factsheet_en.pdf) are the most systemic approaches. The current SEC efforts may get to that level, but it has many hurdles to overcome. In both cases, concerns that enforceable assurance and verification tools are weak. There needs to be a better "trust but verify" set of mechanisms in place. Without them, the ESG-as-is advocates will continue to abet unsustainable investment and business practices.
Paul Brest’s comment above cuts right to the heart of a problem. Using ESG ratings to minimize business risks is almost always conflated with having a positive impact on society. And that’s just not the case. Without shareholder advocacy or some other mechanism beyond using the ratings, I have not seen any firm demonstrate impact.
Excellent article—thank you! It looks like a quick and dirty solution to this problem might be to insist that companies meet all three criteria—the E, the S and the G—in order to be included in any ESG-based index/ranking. That would weed out almost all the examples cited above, I believe.
Thanks for a spot-on article on issues I have looked at over the last couple of months. In addition to what the article cites regarding the "weights" of E, S, and G, it seems to be the case that in most ratings the E gets the lowest weight of ca 15% which means that CO2 emissions or decrease in those can be easily outweighed by high grades in G (weight ca 60% of the score). Also, as covered in a latest OECD review, the ESG ratings measure highly the fact of "disclosure", not "action behind disclosure". As disclosure is easier to achieve by big corporations, these get higher ESG scores. A lot to think about.
Very good analysis of why ESG, sustainability, and risks ratings are not working yet. ESG ratings are still an inexact science painting an incomplete picture. It is commonly accepted that there are over 600 different rating systems from which 6 are dominant. That is 5 too much.
Rather than stop investments altogether just because they are labeled ESG, we should ask what is an ESG rating worth. Rating agencies must come clean first.
Is this a critique of ESG investing or ESG investing with current data and scoring systems? See https://engine1.com/total-value for a "New Way of Seeing Value" that follows the outline of your recommendations
Thanks for this perspective. Two points:
1) ESG vs. Impact: Both need to be taken into account when determining whether a company is doing net positive for the world and likely to succeed financially due to bottom up customer pressure. If a company treats its employees incredibly but the product is killing customers, that’s not good. Similarly, if a company has a product that improves the world but employees are treated poorly, supply chains have modern slavery, etc., that’s not good. Both SHOULD be a part of the calculus—but regulation and investor pressure (e.g., through performance-based investing) need to be there to incentivize companies properly. Right now, those top-down pressures aren’t there, and the bottom-up consumer pressure isn’t enough.
2) On the Impact side of things: It’s really about conducting cost-benefit analysis to determine the net positive or negative impact of the product/service on the world. Pepsi creates sugary drinks, but if used in moderation, they provide a significant amount of QALYs. Lots more to dig into in that direction.
Hans - Excellent article! Great to see your passion for sustainability and humanity shift from agriculture to investment. We have to remember that ESG metrics were created by MCSI as a financial revenue stream, and have grown by the selling of them from investment houses that profit handsomely from them.
There is no correlation between ESG and Sustainability. Institutional investors might ask why 17 unwieldy goals of the United Nations for philanthropy have grown into 44, or 77 goals, with undefined metrics, and no rubrics, in the corporate world. Can you imagine a golf pro giving you 44 instructions before you hit the ball? Who could swing? Not I.
Citizens looking to invest in companies that do not harm the planet, their employees or free markets will have to do their own homework, their own investing, and lot less buying, flying and voyaging. Hopefully, they will continue to eat vegetarian / vegan—sustainably for the planet, and healthy for themselves.
COMMENTS
BY John Sherman
ON July 16, 2021 07:27 AM
Dr. Taparia:
Thank you for summarizing the concerns of many. The shortcomings of the current ESG rating systems need to be addressed. The regulatory and legislative effort underway in Europe (e.g EU Sustainable Finance Strategy, https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/210706-sustainable-finance-strategy-factsheet_en.pdf) are the most systemic approaches. The current SEC efforts may get to that level, but it has many hurdles to overcome. In both cases, concerns that enforceable assurance and verification tools are weak. There needs to be a better "trust but verify" set of mechanisms in place. Without them, the ESG-as-is advocates will continue to abet unsustainable investment and business practices.
BY Paul Brest
ON July 16, 2021 11:58 AM
Some very good points, to which I would add that ESG investments have no impact in improving the behavior of the investee companies. See https://ssir.org/up_for_debate/article/how_investors_can_and_cant_create_social_value
BY Leslie Samuelrich
ON July 20, 2021 06:29 AM
Paul Brest’s comment above cuts right to the heart of a problem. Using ESG ratings to minimize business risks is almost always conflated with having a positive impact on society. And that’s just not the case. Without shareholder advocacy or some other mechanism beyond using the ratings, I have not seen any firm demonstrate impact.
BY Dan Keeler
ON July 20, 2021 12:08 PM
Excellent article—thank you! It looks like a quick and dirty solution to this problem might be to insist that companies meet all three criteria—the E, the S and the G—in order to be included in any ESG-based index/ranking. That would weed out almost all the examples cited above, I believe.
BY Maris Leemets
ON July 22, 2021 07:58 AM
Thanks for a spot-on article on issues I have looked at over the last couple of months. In addition to what the article cites regarding the "weights" of E, S, and G, it seems to be the case that in most ratings the E gets the lowest weight of ca 15% which means that CO2 emissions or decrease in those can be easily outweighed by high grades in G (weight ca 60% of the score). Also, as covered in a latest OECD review, the ESG ratings measure highly the fact of "disclosure", not "action behind disclosure". As disclosure is easier to achieve by big corporations, these get higher ESG scores. A lot to think about.
BY Manuel Vexler
ON July 24, 2021 09:54 AM
Very good analysis of why ESG, sustainability, and risks ratings are not working yet. ESG ratings are still an inexact science painting an incomplete picture. It is commonly accepted that there are over 600 different rating systems from which 6 are dominant. That is 5 too much.
Rather than stop investments altogether just because they are labeled ESG, we should ask what is an ESG rating worth. Rating agencies must come clean first.
BY Pratiksha More
ON August 27, 2021 04:42 AM
Very well written. Thank you so much.
BY Witold J Henisz
ON September 14, 2021 12:03 PM
Is this a critique of ESG investing or ESG investing with current data and scoring systems? See https://engine1.com/total-value for a "New Way of Seeing Value" that follows the outline of your recommendations
BY Evan Vahouny
ON October 6, 2021 08:06 PM
Thanks for this perspective. Two points:
1) ESG vs. Impact: Both need to be taken into account when determining whether a company is doing net positive for the world and likely to succeed financially due to bottom up customer pressure. If a company treats its employees incredibly but the product is killing customers, that’s not good. Similarly, if a company has a product that improves the world but employees are treated poorly, supply chains have modern slavery, etc., that’s not good. Both SHOULD be a part of the calculus—but regulation and investor pressure (e.g., through performance-based investing) need to be there to incentivize companies properly. Right now, those top-down pressures aren’t there, and the bottom-up consumer pressure isn’t enough.
2) On the Impact side of things: It’s really about conducting cost-benefit analysis to determine the net positive or negative impact of the product/service on the world. Pepsi creates sugary drinks, but if used in moderation, they provide a significant amount of QALYs. Lots more to dig into in that direction.
BY PASCAL CARON SAVARD
ON December 22, 2021 03:12 AM
Being too strict would leave ETF’s with very few holdings, therefore
More risky, failing to capture the market growth.
BY Alison Curry
ON March 7, 2022 11:49 AM
Hans - Excellent article! Great to see your passion for sustainability and humanity shift from agriculture to investment. We have to remember that ESG metrics were created by MCSI as a financial revenue stream, and have grown by the selling of them from investment houses that profit handsomely from them.
There is no correlation between ESG and Sustainability. Institutional investors might ask why 17 unwieldy goals of the United Nations for philanthropy have grown into 44, or 77 goals, with undefined metrics, and no rubrics, in the corporate world. Can you imagine a golf pro giving you 44 instructions before you hit the ball? Who could swing? Not I.
Citizens looking to invest in companies that do not harm the planet, their employees or free markets will have to do their own homework, their own investing, and lot less buying, flying and voyaging. Hopefully, they will continue to eat vegetarian / vegan—sustainably for the planet, and healthy for themselves.