The Economist 07Dec2019

The EconomistDecember 7th 2019 71

1

“L

abelling basedon incomplete in-

formation, public shaming, and

shunning wrapped in moral rhetoric,” said

Hester Peirce, a straight-talking commis-

sioner at America’s main financial regula-

tor, the Securities and Exchange Commis-

sion, in June. She was taking aim at the

scoring systems that purport to assess

firms’ performance based on environmen-

tal, social and governance (esg) factors. Yet

love them or hate them, esgscores are be-

coming ever more important in the world

of investing and capital markets. At least

$3trn of institutional assets now track esg

scores, and the share is rising quickly.

In America and Europe some politi-

cians, bosses and investors want to shift

away from measuring corporate perfor-

mance based mainly on shareholder re-

turns. Climate change is another catalyst.

Christine Lagarde, the new head of the

European Central Bank, thinks the institu-

tion should consider using monetary poli-

cy and bank supervision to fight climate

change—a shift that would involve assess-

ing which firms are dirtier than others.

Mark Carney, the governor of the Bank of

England, has championed better disclo-

sures by firms on climate change. Chris

Hohn, the head of tci, a London-based

hedge fund famous for its hard-headed ap-

proach, has outlined plans to vote against

the directors of companies that fail to re-

veal their carbon emissions.

All this is fuelling demand for esg rat-

ings, which create a single score from dis-

parate non-financial indicators, such as a

firm’s carbon emissions or the share of its

board members who are female. Using

teams of analysts, whizzy software and

data from companies, ratings firms collect

esg information and convert it into a single

score. Some customers of esg ratings are

seeking to gain an investment edge; others

want their money to benefit society as well

as themselves. But as Ms Peirce’s criticisms

suggest, the ratings are not yet ready for the

weight they are being asked to bear.

The most obvious sign of this is that,

unlike credit ratings, esg scores are poorly

correlated with each other. esg-rating

firms disagree about which companies are

good or bad. The Economisthas compared

the scores of two big esg-rating systems,

updating an analysis done by the imfearli-

er this year (see chart on next page). It

shows at best a loose link between the two

measurement systems. The same lack of

correlation holds even when the e, sand g

scores are considered separately, accord-

ing to the imf. Small wonder, then, that it

found no consistent difference between

the performance of esg funds and that of

conventional ones.

Moreover, ratings are often based on

business models rather than businesses

themselves. It does not matter what firms

are selling, as long as it is done sustainably.

Tobacco and alcohol companies feature

near the top of many esg rankings. And

many funds marketed on their green cre-

dentials invest in Big Oil.

The scoring systems sometimes mea-

sure the wrong things and rely on patchy,

out-of-date figures. Only half the 1,700-odd

companies in the msci world index reveal

their carbon emissions. Some ratings pe-

nalise non-disclosure—with strange re-

sults. In ftse Russell’s esg rating Tesla, an

electric-vehicle maker, does worse than

firms that make gas-guzzlers. (ftse Russell

says it rates the sustainability of a firm’s

output with another score.) And because

bigger firms are better able to afford disclo-

sure, they tend to get better esg scores. esg

raters say they are tweaking their methods

to remove such biases. But even when fig-

ures are disclosed, they may be too out-of-

date to be useful.

One hope is that the boom raises stan-

dards. Bigger firms are getting involved,

ESG investing

Poor scores

Investors and regulators want to measure how green, cuddly and well-governed

companies are. But the science behind the rating systems is dismal

Finance & economics

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