Why the booming business of ESG ratings may be giving investors a false sense of sustainability

ESG risks can be large. If investors find out too late that corporate performance or strategies have been overstated, with resulting environmental or physical damage, it could lead to legal action and a loss in asset value. There are parallels to the financial crisis, when credit rating agencies gave top grades to mortgage-backed securities, despite complexities that hid their incredibly risky nature and eventually caused financial contagion.

“The real problem at the moment is not necessarily ESG ratings. I think the much bigger problem is the promise that if you buy a fund based on ESG ratings, you have an impact – you change the world,” says Florian Berg, one of the authors of the Aggregate Confusion Project. “There’s no proof.” Besides, there are other ways for investors to influence corporate behaviour, says Mr. Berg – for instance, through shareholder activism. An example is the push by the investment fund Engine No. 1 to replace three directors at Exxon last year, in opposition to the company’s insufficient response to climate risk. The campaign was successful. “Overweighting ESG stocks doesn’t necessarily mean this has an impact on the real world,” he says. “But it is marketed in a way that it has.

The ISSB’s global standards could eventually render some ratings agencies’ practices obsolete and force them to reinvent their offerings to the market, says Emmanuel Faber, the board’s chair. With generally accepted accounting principles, for example, there’s less need to score companies’ financial disclosure practices, and this will be the case with ESG, says Mr. Faber, the former CEO of Paris-based food company Danone SA.

Some companies grumble about their ESG report cards. Moncton-based energy company Major Drilling operates in 20 countries and is working to improve ESG performance in all its branches, says Andrew McLaughlin, its general counsel. “Every now and then, we’ll get this report out of the blue. And then it just sort of deflates the process,” he says. “We’ve got to go chasing down [information] in areas where we just haven’t been tracking.

Source: News Formal (newsformal.com)

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