Vladimir Putin’s invasion of Ukraine is shining a spotlight on the largely unregulated business of ESG ratings, after investments billed as socially conscious bought into a regime that’s now being accused of war crimes.
On the eve of the invasion, about $9.5 billion in funds meeting European environmental, social or governance standards were in Russia, often on the basis of ratings from companies such as Sustainalytics and MSCI Inc.
While ESG raters weren’t alone in misjudging Russia’s belligerence, their exposure is particularly awkward given their analysts are paid to focus on factors such as democracy, human rights and other social and governance factors. Regulators are now calling for urgent work to clarify the myriad standards and practices being used to produce such ratings.
“We need to do some kind of rethinking here,” said Erik Thedeen, chairman of the Sustainable Finance Task Force at the International Organization of Securities Commissions, in an interview. “This disastrous war is an eye opener. The whole ESG community needs to think through how to handle state-owned companies” in countries that violate human rights.
ESG raters crunch vast amounts of data on everything from water use to gender balance to arrive at a grade that can look similar to traditional credit ratings from firms such as Moody’s Corp. or Fitch Ratings. The difference: Credit ratings have evolved over decades, tend to be well understood by investors, and are regulated.
By contrast, there are more than 600 standards and frameworks, data providers, ratings and rankings that are working to measure ESG-related risks, according to the European Banking Federation, a lobby group. (Bloomberg LP, the parent company of Bloomberg News, also offers sustainability ratings and data. Additionally, Bloomberg has a partnership with MSCI to create ESG and other indexes for fixed-income investments.)
| Russia's ESG Rating | Before Invasion | After Invasion |
| ISS ESG | C- (Scale runs from A+ to D- | C- |
| MSCI ESG | BBB |
CCC (Lowest possible) |
| Sustainalytics | Medium Risk | High Risk |
Despite most raters marking Russia down for its record on suppressing dissent at home and aggression abroad, that wasn’t enough to stop it having a green light for ESG investing. MSCI rated it BBB until the Feb. 24 invasion. It subsequently cut the government grade to B, and then to CCC.
In an email, MSCI said Russia’s earlier rating, which benefited from a skilled workforce and an abundance of natural resources, had been “offset” by very low scores on political governance due to issues such as democracy, press freedom and political rights. The rating also had taken into account the annexation of Crimea in 2014, the company said.