ESG Ratings in the News again this week… as calls for consistency and activism grow louder

The connection between the concept of ESG (Environmental, Social, and Governance) principles and the process of providing ‘ratings’ has been a common theme recently, for a number of reasons. On a number of occasions over the past few months, we looked at issues ranging from disclosure standards to sustainability rating agencies’ methodologies. This week, interestingly, the rating universe – that consisting of the credit rating and sustainability rating organisations – have been targeted, but for different reasons. However, both issues are concerned with the concept of ESG, which itself has been the centre of debate for a number of years. As the geopolitical landscape moves in different directions regarding the concept of sustainable finance, the rating universe is seeking to carve out its own place in the arena. However, there are a number of issues being revealed.

 

The first is one that was advanced by the head of Polymetal, the biggest London-listed producer of Gold. Vitaly Nesis spoke widely about the effect of poor practice within the ESG-rating space, focusing predominantly on sustainability rating firms like Sustainalytics or MSCI (although he did not name a particular agency). He spoke of the sector’s ratings as being far too divergent, and lacking any consistency or clarity. Referring to current ESG rating methodologies that amount to ‘tick the boxes’ exercises, he bemoaned the ‘smorgasbord’ of ratings that are produced which make it inherently difficult to, even at least, compare ratings across the board. The obvious example of Rio Tinto having high ESG scores at the same time that it demolished two aboriginal sites in Australia, inexplicably, is used to demonstrate the fickleness of the ESG rating sphere, with Nesis going further by explaining that ‘you can’t base your estimate of the relationship with the workforce, for example, on a self-reported employee satisfaction score. I know at least a couple of ESG score providers who do just that’. Nesis is of the opinion that the resolution is for there to be uniform disclosure standards put in place, like that seen within the framework for the International Financial Reporting Standards. We discussed this recently with regards to plans by IOSCO to set international ESG disclosure standards. However, a more pertinent question is, perhaps, why are ESG rating agencies accepting such poor measures of information in the first place. The answer is rather simple. The ESG rating agencies themselves do not have the authority to demand better, or richer information from issuers. This is because a. the agencies are relatively new players in the marketplace, and b. the sustainable business space, and the concept of ESG, is just a young. We know this because the usefulness of such concepts is still being debated (see the US v the rest of world discussion cited earlier). The question then becomes what effect such actions are having on the dynamic. These agencies are doing what they can to survive, arguably, but this is not building a trust or reputation. If and when ESG becomes a much more accepted concept, why should the market respect organisations that were willing to accept and incorporate such poor information into their processes, such as self-reported employee satisfaction results? They will not, and for this reason amongst many others, the sustainability rating sector of the rating universe is, I believe, operating in the shadow of its own demise.

 

My prediction, which forms part of my forthcoming book Sustainable Rating Agencies vs Credit Rating Agencies: The Battle to Serve the Mainstream Investor, is that the credit rating agencies will simply absorb the sustainability rating sphere and grow larger, in line with the developments within the larger field of sustainable finance. However, their approach is being questioned this week also. The excellent Bill Harrington, who I encourage you to follow on LinkedIn here if you do not already, has called this week for more activism with regards to rating methodology considerations. Harrington is focusing particularly on a recent request for comment from Moody’s (available here) that is concerned with the agency’s proposal to change its ‘cross-sector methodology explaining the general principles for assessing environmental, social, and governance risks’. The short deadline for responses – the 22^nd October – will lead into changes being made on the 9^th January, unless opposition is forthcoming. Harrington seeks to encourage comment to be made, stating in a recent article that ‘if you disagree with Moody’s, push back by submitting critiques that urge it to scrap the proposals and propose a useful one. Equally important, tell Moody’s to shut down the ever-expanding sideshow of ESG “symbols” that deflect from deficiencies in the company’s core product of credit ratings’. The issue for Harrington is that the proposals do not alter the current methodological approach from Moody’s, and ‘in short, Moody’s proposes more of its same credit ratings that ignore many material credit exposures, including ones labelled E, S, and G’. The issues include the ratings addressing physical exposures to aspects of climate risk after the fact, and worse still methodologies and processes being so vague that they only serve to ‘foster the illusion that credit ratings rigorously incorporate the credit impacts of physical exposures’. Rather remarkably, the proposals would not necessarily lead to any alterations in ratings, either way, as a result of the changes; ‘if the cross-sector methodology is updated as proposed, we expect no changes to outstanding ratings for all sectors globally’. The question then is, why bother? A cynic may suggest that this is a box-ticking scheme that can be said to be responding to changes in the marketplace and wider environment, but only in name only. For this and many other reasons, Harrington urges interested parties to engage with the process and offer critique of the plans, and he has offered to provide assistance in the form of review and discussion with those that do – refer to his article cited above and his LinkedIn for more information.

 

The rating universe and the concept of ESG are becoming ever-more intertwined, but this is not necessarily positive. The new market is revealed age-old inadequacies within the universe, and the repetition of many of these inadequacies only serves to highlight how central they are to the performance of providing third-party ratings. However, more engagement and consistent critique can play at least some part in forming a better dynamic as its importance continues to grow. No doubt there will be more stories of this type in the near future.

 

Keywords – ESG, rating, Moody’s, @finregmatters