ESG Moves Towards a Single Standard
Has the Hydra-headed, variously defined beast known as ESG finally been harnessed into a single, overarching authority for values-driven investment?
ESG-driven products have continued to attract billions at a rapid rate during the last year, including a record $36 billion in October alone. The market keeps calling for a common set of rules to guide and govern such investments in a sector with an estimated 600 different ESG rating frameworks. Has that call been answered?
A newly created organization, The Value Reporting Foundation, formed by the merger of the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC), looks to have stepped up to try. The foundation’s proposed goal: “providing investors and corporates with a comprehensive reporting framework across the full range of enterprise value drivers and standards to drive global sustainability performance.”
Both SASB and IIRC, leaders in their respective areas of operations, had asked for such joint action, along with some other climate-focused groups, including CDP (formerly the Carbon Disclosure Project), the Climate Disclosure Standards Board (CDSB), and the Global Reporting Initiative (GRI). Each of these organizations has distinctive origin stories and specific missions. But they share the common objective of establishing a reporting system that can measure and manage financial factors in business that are affected by climate change. Now, these multiple and overlapping systems look to become aligned (the “how”—the real nitty-gritty of the doing— is to be determined), creating a simplified reporting framework that will offer guidelines for practices, benchmarks and taxonomic definitions — in short, a commonly agreed-upon set of rules and regulations by which investors and advisors can confidently operate.
The SASB-IIRC merger is a result of the larger group’s manifesto, the Statement of Intent to Work Together Towards Comprehensive Corporate Reporting. In a statement, the Value Reporting Foundation says that it could “eventually integrate other entities focused on enterprise value creation.” Talks with CDSB are apparently underway, so presumably we’ll see more such integration of climate investment forces in the future.
Is this all happening a little too fast? While I am definitely an advocate for a more unified ESG investing sector, the more I dig into the issues at a granular level the more aware I’ve become of several speed bumps studding the ideal highway to a single, comprehensive ruling authority.
Six ESG’s in Search of an Authority
Some of those issues are outlined in a paper from the MIT Sloan School of Management—a 64-page tome I have only recently managed to finish. The title is appropriately descriptive: “Aggregate Confusion: The Divergence of ESG Ratings.” It’s a deep dive into the data of six prominent ESG ratings agencies: KLD (MSCI Stats), Sustainalytics (now part of Morningstar), Vigeo Eiris (Moody’s), RobecoSAM (S&P Global), Asset4 (Refinitiv) and MSCI. The authors — Florian Berg, Julian F Kölbel, and Roberto Rigobon — focus on differences in three areas:
1) Scope of categories
2) Measurement of categories
3) Weights of categories
The bottom line: The researchers “find that scope and measurement divergence are the main drivers, while weights divergence is less important.” In an additional finding, they “detect a ‘rater effect’ where a rater’s overall view of a firm influences the assessment of specific categories.” While the paper doesn’t deliver a clear view of the proprietary platforms of each agency, you do get a good sense of how ESG works within their different systems. For a sobering splash of cold reality, read the entire paper to get a full picture of current, existing complexities.
Four Things No One Will Tell You About ESG
Another paper, published by Harvard Business School, adds more fuel to this bonfire of confusion. “Four Things No One Will Tell You About ESG” expands on “the lack of transparency among data providers about peer group components and observed ranges for ESG metrics.” The bottom line finding by authors Sakis Kotsantonis and George Serafeim is that differences, discrepancies and disagreements inevitably create confusion in the ESG investment marketplace. Surprise, surprise. If you needed confirmation that a sole authority was necessary, this research proves the case.
In fact, today’s cautionary studies may be more of a look into the rear-view mirror: See the above-outlined efforts by SASB, IIRC and others to integrate resources.
More evidence of consolidation: In a strong vote of confidence in ESG as a reliable process (if not yet a unitary practice), Morningstar has integrated ESG into all its investment analysis. The company’s equity analysts are using Sustainalytics ESG Risk Ratings to evaluate a company’s exposure to material ESG risks. (Morningstar acquired Sustainalytics, an ESG ratings pioneer founded in 1992, this past summer.) Research results will factor into Morningstar’s assignment of a stock’s value of between one and five stars.
The more that ESG factors are judged as material to the bottom line, the more we should watch for this consolidation process to continue. These may once have been seen as “non-fiduciary” matters, but they are fast becoming key to all investment. Just follow the money.
Article by John Howell, a writer, editor, and broadcaster who oversees the Climate Finance Weekly newsletter for Climate & Capital Media and advises on communications and media strategy. He was co-founder, editorial director, and chief of thought leadership for 3BL Media, for which he managed all original editorial content, wrote, and edited newsletters, and created the Brands Taking Stands initiative. He has worked as an editor and contributor for Elle, Artforum, and High Times magazines, developed new media for Hearst Magazines, and created communications for Calvin Klein, Polo/Ralph Lauren, and The Body Shop. He lives and works in New Hampshire and Maine.