Boohoo Brings Criticism of ESG Rating Agencies Back to the Fore
The Financial Times has been asking the question
recently ‘why did
so many ESG funds back Boohoo?’, which is not surprising given that it was
the FT who conducted investigations
into the appalling working conditions within Leicester in the UK. Those investigations,
which were unfortunately not really acted upon until the recent spike in coronavirus
within the city saw it locked down, have since led to financial
repercussions for Boohoo, one of the biggest benefactors of the underground
textiles industry within the region – the firm started as a street market stall
and, up until the recent scandal, was valued at almost £5 billion. Since then,
the value of the firm’s shares have halved, and the company is now being
subjected to a number
of official investigations, with the company itself performing internal
investigations regarding its supply chains.
The allegations levied against the firm are beginning to
have a wider effect. Analysts have been quoted as suggesting that the scandal
has ‘sent
shockwaves through the ESG investing world’, with a number of investors and
funds who champion their adherence to ESG-related principles currently holding investments
with the firm, and a number of ESG rating agencies still providing he firm with
high scores, some much higher than the industry average. MSCI is the ‘agency’
being cited most frequently in the business press in this regard, particularly as
in a June update to its rating it reiterated
its Double-A rating for Boohoo which places it within the top 15 percent
for fashion retailers. More strikingly, one
of the reasons for such a high score is in relation to the company’s supply-chain
labour standards. However, MSCI was not alone, with nine ESG rating agencies
being cited for not having flagged any controversial practices at Boohoo;
although, its competitor ASOS was flagged for its practice of sourcing
materials from Burma and Sudan, which were flagged as ‘potential
risk factors’.
Because of the rapid
increase in interest within the sustainable finance marketplace, the
criticism is rightly being shared out across the spectrum of those involved in
this particular market. The ‘rating dynamic’ as I call it – consisting of
rating agencies, investors, issuers, and regulators – is again at the core of
the criticism. For example, whilst one analyst argues that ‘investors
who only looked at the ratings or the ESG data the companies disclosed could
easily believe that Boohoo was a pretty good investment from an ESG perspective…
the reliance on simple ESG ratings or solely on publicly available information
disclosed by the company, can lead to some fundamental errors’, another argues
that ESG rating agencies ‘can only work with the data that a company discloses
in the first place’. So, should investors do more? A number of commentators
have been tremendously critical of investors regarding Boohoo, arguing that ‘the fact
that Boohoo ended up in so many sustainable funds shows the callous
infrastructure of our investment system, and its participants’ and that
investors piled into Boohoo’s stock because ‘they knew Boohoo was making money
and they didn’t ask any questions’. The commentator continues by declaring that
‘there’s a long way to go with shareholders to get them to ask the questions on
due diligence on human rights that they’re supposed to’, although the previous
understanding that investors just want to primarily make money (even including
sustainable investors) perhaps holds true (with regards to those invested in
Boohoo) when one fund manager makes the glaringly obvious but no less impactful
statement that ‘it would
be very difficult to make a £5 dress without cheap labour in the supply chain’.
This is widely known and understood, yet rarely declared, unless it is in the
form of financial-speak, like when asset managers have been discussing the 10% trading
margin witnessed at Boohoo and had to ultimately declare that if one were to
comply with UK legislation regarding minimum wages, ‘it
is difficult, nay impossible, to achieve such a margin’. The market, in considering
the effects of this scandal, have noted that the only future for the fast
fashion market will be one leading to ‘either prices rising, which would mean
reduced competitiveness and potentially lower volumes, or lower margins’. If we
focus on the investors, many of who loudly champion their adherence to sustainable
principles, holding investments in such a company, the real question is how can
they do so a. with a clear conscience, and b. without having received criticism
before now? After all, the original FT investigation was published in 2018,
with the author appearing before Select Committees in the British parliament
(although no further action was taken).
One way they are able to do so is, simply, that the ESG
rating agencies provided them with the ‘third-party’ certification to do so.
Yes, ‘whilst
ratings provide a useful reference point, ESG managers need to do their own
research to ensure that their clients are not compromised by having investments
that are not aligned with their values’, but another issue is that fund
managers must do more to question the ratings they are utilising, whether in
part or in full (which they are not supposed to do, technically). The FT cite a
corporate governance specialist who asks ‘who is
doing a good job to make sure the rating is accurate?’, and that the agencies ‘have come up with elaborate
scoring systems, which mean you can do really well in some areas and be really
poor in another but get a pretty good score. But that can be quite a critical
area – I’d argue a supply chain should be a red card issue’. Scope Ratings have
weighed on this, stating that ‘a company may not know what the problems are in
its own supply chain and this cannot disclose them’, but it is the case that ‘ESG
rating agencies often calculate their ratings or make their investment decisions
based on the available data and simply ignore the missing data’. A cynical
viewpoint would be that this ‘opens
up an opportunity for companies to game the system. If you have something to
hide, you can simply choose to disclose only favourable information about your
company… this way, you look much better to ESG investors and it may even be
possible to look better than companies that are following better practices
overall, but disclose more information about their business’.
Either way, this is almost a game of ‘pass-the-parcel’,
where the parcel is blame. There is plenty of it to go about, but nobody is
willing to accept it (for obvious reasons). Investors need to do more in
questioning the rating they are utilising, not just using it for certification
purposes to enter into investments they really ought not to be involving
themselves with. ESG rating agencies must do much more to ensure their ratings
are as informed as is possible and, if they are not, the absence of information
must both be factored into the overall rating fundamentally, but aspects such
as supply chains in the fashion industry should be ‘red card’ issues as some
have suggested. Regulators and legislators need to do much more in terms of
enforcing disclosure practices on elements of ESG, not just the ‘G’. Consumers
themselves have a part to play, although there are mitigating factors such as
social media channels bombarding the target market with information in the
favour of companies like Boohoo, and not information regarding the absurd suggestion
that clothing can be sold at this price without there being a human cost
somewhere in the chain, and also the target market being subjected to a number
of pressures like unemployment and low wages etc. – yet, the consumer does have
a role to play and is currently not doing so. It raises the question of the
role of the ESG rating agencies (and arguably the credit rating agencies also);
should they do more to verify the information they are given, or is it a
disclosure-based issue where it is somebody else’s job to enforce such
standards, like a regulator? Is there perhaps scope for an audit-style industry
for ESG disclosure, where ESG audits could be signed off and fed directly into
the rating process? Many questions for sure, but one aspect stands out above
all else – why are ESG rating agencies certifying companies that they do not
have all the information on, and why are investors then using this
certification to pile into companies which have question marks around its
ethics and practices? The answer is that there is money to be made in taking
such actions. The reality is, however, that for those working within
Victorian-like conditions within the East Midlands, part of one of the most
developed countries on the planet, such benefits do not reach down to where
they are and whilst investors can now remove their funds from Boohoo in disgust
at the scandal, the damage has already been done.
Keywords – ESG rating agencies, Boohoo, fast fashion, @finregmatters
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