The sheer diversity across firms grading companies is leading to disagreement and confusion
In order to create ESG profiles for companies, ratings firms are increasingly paying attention to non-financial data points. But while they’re getting better at connecting such dots to form a picture, there’s still plenty of disagreement over which data points should count.
As noted by The Wall Street Journal, ESG ratings firms such as MSCI and Sustainalytics have long considered non-financial factors like emissions and labour policies. The practice of flagging potentially material ESG factors — particularly those with regulatory or reputational implications — has also been spreading to equity analysts and credit-rating firms.
But the myriad techniques and methodologies firms use to derive ESG scores have created a hard-to-navigate landscape for values-focused investors. Heavy reliance on voluntary disclosures by companies has contributed to inconsistencies across industries or time periods. To patch up gaps, scoring firms supplement company reports with analysts’ surveys, interviews, and online sources.
“From there analysts apply varying weight to factors they think are most relevant to a given industry,” the Journal report said. “Each firm has its own formula, its own process.”
Citing experts who track ESG data, the report said at least 200 firms are providing ESG ratings, and the ratings vary in scope from overall ESG performance to niche topics like gender pay equity. Over the past decade, large players like MSCI and Moody’s have muscled their way into the scoring space through consolidation and acquisitions. Other participants like S&P and State Street have come in through homegrown evaluation tools and partnerships with esteemed academic experts on ESG.
Companies themselves have responded to the rising interest in sustainable finance by more rigorously tracking and reporting their progress on ESG metrics. But their methods of monitoring are also widely disparate, creating a disconnect between their self-evaluated performance and how others score them.
“Take L’Oréal SA, which has invested in its corporate-ethics division since the appointment of its first chief ethics officer in 2007,” the Journal said. According to the company’s Chief Ethics Officer Emmanuel Lulin, it tracks its ESG scores from several major providers, and often agrees with reports of shortcomings issued by analysts. But he added that such assessments don’t capture “important elements of a company’s workplace environment that can be difficult to ascertain from the outside,” including efforts to encourage employees to report harassment or other potential misbehaviour.
“I think there is not enough focus on the culture,” Lulin said. “It’s more difficult to do, because it means more investment in getting to know the company and getting to know the people.”
Investors are counting on regulators and standard-setters to promote consistency in non-financial disclosures. In 2018, companies in the European Union saw the implementation of a requirement to divulge information on social and environmental issues within their annual reports; academics and investors also called for the US Securities and Exchange Commission to develop an ESG disclosure framework.
While the ESG scoring space is still noisy, annual reports can still provide useful signals: more than a year prior to the hacking scandal that rocked Equifax in 2017, MSCI gave it the lowest ESG marks possible due to security and privacy concerns. Facebook also received a downgrade months before its connection to a voter-profiling firm’s improper scraping of data from tens of millions of Facebook accounts came to light.
