Fixing the Nine Flaws of ESG Analysis: From the Deep Water to Horizon

A year ago the explosion on Deepwater Horizon unleashed the worst environmental disaster in US history. For those who subscribe to the idea that environmental, social and governance (ESG) analysis makes for enhanced risk analysis, it was a costly blow, as BP had been rated well by many ESG analysts, and the stock took a dive after the disaster. For those who believe that ESG analysis leads to meaningful engagement by responsible investors to improve a firm’s social or environmental performance, the evidence that many investors had asked BP about their poor safety record over the past decade, to little effect, also presented a conundrum.

Although the responsible investment community now comprises over 20 trillion Assets Under Management, and along with it some new ESG millionaires, overall we are not seeing effective pressure on firms to be more responsible. Instead, we hear CEOs blaming the financial markets for short-termism limiting their investment in CSR, the ESG analysts blaming investors for not paying enough for better research, and the SRI heads in financial institutions blaming regulators for not empowering them or quietly admitting that their efforts are dwarfed by their colleagues’ exuberance for exotic derivatives, dark pools, high-frequency trades and other shenanigans that most of us get lost on.

Repeating the mantras that ESG analysis is good for returns or good for society won’t make them true, just like spraying detergent on oil won’t make the toxicity disappear. Instead, the flaws of ESG analysis and ratings need fixing, as part of a new attempt to make socially responsible investment funds, and self-proclaimed responsible investment institutions, deliver more for society, and for those citizen-savers among us who don’t want our nest-eggs to trash the planet. Today, The Journal of Corporate Citizenship publishes an analysis of the flaws of mainstream ESG analysis, some reasons for this situation persisting, and some ideas on how to begin fixing it.


After consultations with dozens of reflective practitioners and academic critics, the study finds that many ESG analysts and raters:

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1. rely predominantly on information published or provided directly by the companies being assessed, or by media that republish corporate communications. That is problematic because companies with challenging ESG issues are more likely to communicate on these issues, and when they do it is with their particular opinion and choice of issues and data.

2. focus their analysis on management policies and processes not on the actual ESG impacts and outcomes of the companies assessed. That is problematic because companies with challenging ESG issues are likely to have more developed policies and programmes, but that does not mean they have the least negative or most positive impacts.

3. assess companies within a downside risk framework, focusing on the management of negative externalities that can lead to damage to reputation or litigation. That is problematic because it does not consider which companies are creating more social or environmental value for society, particularly where doing business in certain countries may be imply greater potential for both positive or negative impacts.

4. use limited frameworks for understanding the complex and evolving field of corporate responsibility, and reductionist methods to assess companies, due to their commercial interests limiting the time, skills and advice available to them. This also means combining issues which perhaps should not be treated equally, and a numerical masking of cultural bias of the analyst organisation and the individual analysts.

5. are not completely independent from the companies that they are rating, with a variety of conflicts of interest that need to be managed.

6. conflate the materiality of ESG issues for financial performance of investments and the materiality of those issues to affected stakeholders and wider society. Some make assessments based on financial materiality and others involve more moral judgements. In both cases the credibility and accountability of those judgements are in doubt.

7. run indices or supply data to indices that include all forms of enterprise including ones that can never be sustainable (e.g. oil), and thus blur the issue of what is responsible investing for fund managers and private investors, as well as regulators and the wider public.

8. do not integrate their ESG analysis products and ratings with the mainstream financial analysis products and ratings that their own firms or owners offer clients, partly because of a commercial interest in maintaining different products. That is problematic as it restricts the potential to integrate ESG considerations in mainstream financial investment analysis.

9. are not transparent about their methods of research, analysis, and ranking, or about their general operations, for stakeholders and regulators to assess their credibility in light of the weaknesses described above.

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There are a variety of initiatives to address some of these limitations. For example, on April 13th STOXX, a European index provider, and Sustainalytics, the ESG investment research firm, announced a new series of ESG indexes, which they say is transparent, allowing investors to fully understand which factors determine a company’s ESG rating. But is enough being done to make a substantial difference to the impact of responsible investment?

In discussions on how we might increase the impact of responsible shareholders, the creation of credible new standards are often mentioned. In other fields of voluntary action on responsible business, standards have played a critical role. My first job was supporting the Forest Stewardship Council (FSC), whose certification system now covers 11% of the worlds trade in wood and wood products. My second job was co-designing the Marine Stewardship Council, whose certification system now covers 6% of the world’s fish catch. Given this background, you might expect I sense that standardisation in the responsible finance space is inevitable. But the important questions are what standards, designed by whom, for what purpose and with what effect? Standards can inform or obfuscate, serve public needs or increase occupational closure. Whose interests are represented in standards development, implementation and monitoring are key to whether they promote the common good or not.

So how might we help standards to enable more effective responsible investment? Is the Corporate Sustainability and Responsibility Research Voluntary Quality Standard enough, or is it too cautious in addressing the flaws outlined above? Should the Global Initiative for Sustainable Ratings (GISR) receive more backing to become a serious player in this space? Are the professional standards of the Responsible Investment Academy in Australia sufficient, and how might we tell from the outside? Should the UN-backed Principles for Responsible Investment (UNPRI) develop more verifiable criteria for best practice amongst its leading members? Or is there a need for a substantive multi-stakeholder initiative, that involves governments and civil society more fully and directly in creating standards for ESG analysts, responsible investment institutions, and the professionals who work within them, with the broader public interest in mind?

Four years ago at WWF we imagined a multi-stakeholder initiative on creating a financial system that would serve people and planet, which today is called the Finance Innovation Lab, based out of London, and co-hosted by WWF-UK and the ICAEW. At the General Assembly of the Lab earlier this month, we launched a “Standards and Governance” group to provide a space to explore the potential for a multi-stakeholder approach to further standardisation in responsible investment. To encourage this exploration, the study in The Journal of Corporate Citizenship will be serialised on its social network, with one flaw in ESG analysis discussed in depth each week, along with various ideas for how to improve practice. That is one place you can share your views and initiatives.

It was commitment to the greater good that helped to create the field of responsible investment. So even as it has become an industry and profession, we can recall that original intention. Responsible leadership transcends the blame of “others” and “systems” by engaging others to change those systems. So rather than pointing the finger at an “other” that is a barrier to change, or protecting the narrow interests of our own organisations, together we could revive that spirit of responsible leadership to make responsible finance deliver for the public, as well as private, good.


Dr Jem Bendell


Director of Lifeworth Consulting
A co-originator of the Finance Innovation Lab.
Greenleaf Author


Note: This blog is based on the latest edition (issue 40) of the Journal of Corporate Citizenship.


This blog originally appeared on Responsible Investor

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One thought on “Fixing the Nine Flaws of ESG Analysis: From the Deep Water to Horizon

  1. It’s clear, without any great pressure from stakeholders, especially in the definitions of ESG standards and how these can be verified, improvements are not possible on any substantial negative externalities, but only on certain aspects of little importance.

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