ESG Ratings: Naive Hubris or a Practical Solution for Investors Seeking Responsible Outcomes?

It may come as some surprise that sustainable investing turned a corner as the Covid-19 pandemic upturned the world and played havoc with financial markets.

The global disruption has brought into sharp focus the need for a more responsible approach to world politics and capital allocation.

The vaccine roll-out has switched on the light at the end of a long tunnel and investors are committed more than ever to making the ‘right’ investments, as the lens is once again fine-tuned on climate change and social equality issues.

While Environmental, Social and Governance (ESG) ratings can help investors determine the future financial risk of companies and evaluate their behaviour, specialists within the sustainable investment field are questioning how ESG ratings are defined and quantified.

Making money and creating positive change is an attractive proposition, but ESG data must be accurate and transparent to achieve this.

While impact measurement has been around for a while, it is a relatively new concept for the financial services sector, leaving it sorely lacking in comparison to the level of expertise that organisations in the public and philanthropic/charitable sectors have already been demonstrating for some time.

The incorporation of ESG factors offers a wealth of opportunities for financial service providers to create greater value for society, but discrepancies and fears of inconsistency have been creeping in regarding the varying methods by which investment firms are classifying companies and incorporating this information into their execution process.

With disparities in the generation of raw data from an assortment of data providers, and methodologies and frameworks used by investment firms lacking in consistency, it is little wonder traditional ESG data platforms, and their scoring methodologies can be regarded as not fit for purpose.

In turn, this has led to suspicion and, in some cases, accusations that some firms are ‘greenwashing’ their portfolios as demand intensifies for strategies that are ESG-compliant and, increasingly, also impact generating.

However, change is afoot. Calls are being made for regulation and consistency to overcome the challenges and it appears that adopting accountancy-style practices and principles is the emerging consensus required to do so. We expect the IRRC and SASB merger to be a key factor in that space over the next few years.

We are seeing increasing examples of better-informed investment decisions being made through the incorporation of proprietary research and data analytics focused specifically on an individual environmental or social factor across our client base.

The UN’s Sustainable Development Goals (SDGs) are being adopted by many companies who want to accurately measure their social and environmental impact. While the blueprint of 17 goals can act as a roadmap for investors, supplementary information is needed as the SDGs were not designed to be used to drive an investment process.

The Sustainable Finance Disclosure Regulation (SFDR) is also helping to address the issue with a set of sustainability-related disclosures for financial market participants and financial advisers.

So, while progress is being made, there is still a long way to go, with huge opportunity for firms who seek to go the extra mile in unlocking the value-creation potential of material ESG factors.

Below is a list of some of the key market players who are working to improve existing ESG data provision:

Established Players:

• S&P Global (incorporating both Trucost and IHS Markit)
• MSCI
• Morningstar (incorporating Sustainalytics)
• Moody’s (incorporating Vigeo Eiris)
• LSEG (incorporating Refinitiv)

Disruptors/Boutiques:

• Arabesque
• Preqin
• Net Purpose
• Integrum ESG
• Factset (incorporating Truvalue Labs)
• Neural Alpha

Leading Proprietary Tools:

• Schroders (SustainEx, ThemEx)
• LGIM (Future World)
• Morgan Stanley (Impact Quotient)
• Lombard Odier (LOPTA - Portfolio Temperature Alignment Tool)

NGOs:

• IRRC and SASB (due to merge into one organisation by mid-2021 to simplify sustainability disclosure)
• GIIN
• UN SDGs
• The Investor Watch Group (Carbon Tracker, Planet Tracker)

Katy Quicke specialises in Sustainable Finance and Impact Investing executive search and advisory work at Acre. She has seven years of dedicated financial services recruitment experience across banking, investment management and private equity.

To discuss recruitment requirements or career opportunities, Katy can be contacted at: katy.quicke@acre.com​.​​​