Ratings used for ESG investing face criticism
Today’s edition of The New York Times featured an opinion piece that criticized ESG investing – not from the view that investing “in stocks” is economically counterproductive. (For this view, the Wall Street Journal editorial page usually provides a platform. (https://www.wsj.com/articles/esg-threat-goes-beyond-blackrock-larry-fink…). , this article criticized ESG investing on the grounds that investments currently labeled as ESG compliant are in fact not compliant with ESG principles.
Specifically, the article opined that companies are considered ESG-friendly not based on “their degree of environmental or social responsibility”, but rather “the magnitude of the potential harm that ESG factors such as carbon emissions have on the financial performance of companies”. In other words, this criticism has focused on the idea that ESG-compliant investing should focus on corporate social responsibility, rather than the economic risks that companies face due to the energy transition resulting from climate change.
Basically, the article criticizes the current ESG rating system and argues that instead of “measuring the risks that environmental and social developments pose to companies, evaluators and investors should measure the risks to humanity posed by businesses”. In particular, the author recommends that “rating agencies [should] measure the costs to society and the environment that are not directly borne by business – what economists call negative externalities. This would include health care costs to society related to smoking or excessive consumption of sodas or accelerating climate change due to greenhouse gas emissions.” Such a system would be a significant departure from to the various ratings currently provided by the rating agencies.
This criticism, even if it goes much further, echoes recent statements and enforcement actions by the SEC, which are concerned about the phenomenon of “greenwashing”. It seems likely that this public and regulatory pressure will cause investment funds to be more deliberate in developing ESG-compliant investment vehicles, and possibly to adapt a more rigorous approach to the criteria for selecting investments that would be considered appropriate for ESG-focused investing. .
Perhaps the biggest problem is the ratings industry. To construct ESG funds, investment managers rely on ratings agencies – such as Sustainalytics, S&P and MSCI – which create indexes of sets of companies that are deemed to be good corporate citizens. (Some examples are the Dow Jones Sustainability World Index and the MSCI ESG Universal Indexes.) These agencies also rate companies on ESG criteria and sell the ratings to investment firms. But contrary to the spirit of ESG investing (and probably unknown to most investors), the major rating agencies do not rate companies on their degree of environmental or social responsibility. Instead, they measure the potential impact of ESG factors such as carbon emissions on companies’ financial performance.
©1994-2022 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, PC All rights reserved.National Law Review, Volume XII, Number 272