ESG Ratings: fact or opinion?

ESG ratings and collating the statistics

ESG funds are among the fastest growing; and as sustainable investing becomes the mainstream for financial hubs, companies are doing everything they can to come across as sustainably and ethically run. However, agreement behind ESG certification and ranking, lags behind the growth at which businesses are claiming to be ESG friendly. In turn, the ratings in place that money managers rely on, are not capable of filtering out the greenwashers; those that talk the talk but aren’t walking the walk.

Analysis of six ESG rating provider companies scores of 400 different companies, only had a 50% correlation with each other’s statistics. There have been several other recent reports to suggest similar mismatching due to methodology, measurement and/or aggregation. The obvious issue here is investment being poured into funds that aren’t necessarily as ESG heavy as they appear to be. However, on the flip side, it also makes it difficult for companies who are doing everything they can with regards to ESG, to stand out against the rest. There needs to be consistency across all sectors on how carbon emissions, as one example, are measures and weighted, particularly in the absence of companies providing this information themselves. With enough resource, funds as well as portfolio managers can do their own work on ESG ratings, however its much less likely for smaller establishments to be able to carry this out. Consistency and legitimacy would be a lot higher if ESG rating agencies could standardize this practise.

Combating greenwashing

That’s not to say that progress isn’t already being made. Andy Moniz, a London based Data Scientist, has figured out a solid approach to combat greenwashing within ESG ratings. Not only this, but the method he’s produced, he can make money trading on. “I became frustrated with what the ESG data providers were doing” he said. “A lot of the time they’re just relying on yes or no answers to questions like ‘does this company have a human rights policy’. That data is extremely stale and backward-looking”. Hence why Moniz is now using advanced tools such as natural language procession and machine learning to collect the data himself.

Moniz’ software searches through transcripts of speeches and meetings, sustainability reports, conferences etc to pick out signs of evasiveness, refusal to answer and vagueness. He suggests that despite companies working hard to carefully word their sustainability reports, nuggets are still to be found. He points to the Polish coal-fired electricity company Ze Pak SA, which claimed in a recent presentation that by 2029 it would achieve “climate neutrality”—an even more ambitious target than net-zero—without providing any clues as to how it planned to do so. However, it’s not recognizing the red flags that are the tricky part, it’s building a system that is capable of processing millions of different documents and teach itself what it’s looking for.  For him, it’s then about working out how to translate that to finding investment returns. Unfortunately, even when greenwashing has been found within firms, it’s no guarantee that it will cause their shares to go down.

It’s clear that regulators are starting to wake up to the shortfalls of ESG ratings, however there is more work to be done to make it an effective tool. Mandatory reporting, comprehensive standards and increasing transparency are just a few critical pointers to improving ESG ratings legitimacy otherwise they will remain as opinion only and fall short of distinguishing the good from the evil.