(Bloomberg LP provides ESG disclosure scores based on company-reported ESG data and also offers third-party partner data and scores on its terminal.)
To give an idea of how much ratings can differ, look at a sector such as tobacco, which many sustainable investors have excluded for years. Based on most recent rating reports from this year, Munich-based sustainability ratings provider ISS ESG rated British American Tobacco Plc weak, indicating high risk, while Sustainalytics gave the company a score of 24.4, which represents a medium risk on its scale.
“Half of overall divergence derives from different weights, the other half from different evaluations within categories,” says Julian Koelbel, one of the co-authors of the MIT paper. “Judgment and opinions vary as a result of these differences.”
ESG ratings have also proved far from perfect at detecting impending disaster. One of the most prominent recent examples is PG&E Corp. The California-based utility was forced into bankruptcy in January 2019 after its equipment was blamed for two years of deadly fires that destroyed thousands of homes and businesses and cut power to more than 45,000 customers.
Some ESG data and ratings providers gave PG&E good ratings before its demise, according to Opimas’s Pierron. At least one provider highlighted safety concerns with the utility’s equipment before the 2017 and 2018 fires: On a scale of 1 to 5, with 1 being the lowest risk, Sustainalytics rated it category 4 or higher on quality and safety after a fiery explosion of its San Bruno pipeline in 2010.
Seeking Standardization
ESG data and ratings providers aren’t regulated, unlike counterparts focused purely on financial information. Nevertheless, efforts are being made to bring more transparency and standardization to the industry.
New European Union taxonomy—set to be fully enforced by the end of 2022—will introduce disclosure requirements for index and benchmark providers that use “sustainable” and other labels. “They will have to provide full transparency on their ESG indexes, notably, regarding methodologies and data sourcing, but also follow clear guidelines around the criteria implemented according to the asset classes being included in the index,” Pierron says. “These new obligations will push the industry toward a higher-quality standard.”
Still, ratings providers say their systems will improve significantly only if companies worldwide are forced to report relevant sustainability data. The EU currently requires large companies to regularly publish reports on the social and environmental impacts of their operations. The China Securities Regulatory Commission is making it mandatory for all listed companies and bond issuers to disclose ESG risks by 2020. But the U.S. Securities and Exchange Commission, the financial regulator for the world’s biggest economy, doesn’t require corporate disclosure of material ESG data.
While some companies may voluntarily disclose ESG data, there isn’t an enforced standard on how they should do it. “The main challenge is lack of coherence in ESG disclosures by companies,” says Sylvain Guyoton, senior vice president for research at Paris-based sustainability ratings company EcoVadis.