MIT Launch “The Aggregate Confusion Project” to Work on ESG Rating Problems

In March 2020, when discussing concerns that had been raised regarding the ESG Ratings arena, we saw how an article developed by Professor Roberto Rigobon, Dr Florian Berg, and Dr Julian Kölbel argued that there are inherent divergences witnessed between the ratings within the ESG rating arena, and provided for a number of reasons as to why. Recently, via MIT and the MIT Sloan Sustainability Initiative, the team are launching the Aggregate Confusion Project to tackle those issues. 

The paper, published in August 2019, is entitled ‘Aggregate Confusion: The Divergence of ESG Ratings’ and is certainly worth reading. Its findings are particularly important, particularly in relation to the effects of measurement divergence in a range of contexts. Without spoiling the paper for those that have not read it yet, the key to the paper is understanding and demonstrating the ‘rater effect’ and how that is currently impacting upon the stunted development of the industry. More worryingly, the scholars find divergence between the identified agencies on factors that should not be causing divergence, like factual elements of whether a company is signed up to a global initiative etc. The article makes clear conclusions, and leave the door open with regards to the potential for the industry to develop if it becomes more transparent. In my forthcoming book Sustainable Rating Agencies vs Credit Rating Agencies: The Battle for the Investor, I argue that there are underlying factors that will ultimately, and negatively affect the trajectory of the ESG rating industry, but the findings in the article were vital components of that book. 

The new initiative ‘aims to develop a set of ESG tools and methodologies that will become best practice’. The overarching aims are to ‘make ESG integration more defensible and more workable for the industry, and to that end the project is now seeking asset managers and asset owners to join their team to make the research practicable. The team have suggested that whilst prospective member organisations will have different capacities and appetites for ESG integration, there will be a number of common tasks to be achieved, including:

·       Reduce the level of noise in measuring specific ESG categories such as labour treatment, carbon emissions, and product safety;

·       Understand the effect of ESG-driven investment flows on stock price and firm behaviour;

·       Develop smarter ways to aggregate ESG factors into composite indices; 

·       Reliably assess investor preferences to enable ESG indices to be more customized and attuned to investors’ values.

Details on how to contact the team are available on their webpage.

Whilst it is questionable whether ESG rating agencies, as they are understood, can satisfy the needs of the market they exist to serve, it is certainly important that they become more efficient; this project is a really positive step forwards. If the ESG rating agencies can have a closer connection to the market participants who use their products, then maybe the will not be a need to go elsewhere in search of obtaining the information, in the form that they need, as I have predicted. Nevertheless, the ESG rating agencies should be monitoring how the project develops because they could benefit greatly from the future connection to the market that the project will hopefully develop – there is scope for this project to become the PRI Credit Rating Initiative of the ESG Rating arena, which could be very impactful (despite the drawbacks of the PRI project as I have identified in other works).

 

Keywords – ESG, Rating, ESG rating agencies, MIT, @finregmatters

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