Week 48: Say goodbye to ESG ratings

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Dear all,

It’s time to say goodbye to the current ESG ratings used by the financial industry across the world. It's a goodbye that’s long overdue, an easy goodbye, almost like a walk in the park. Because we’ve seen enough.

The current ESG ratings, provided by a number of firms around the world, are hurting the very intent of ESG investing. Why? Well, because today’s ESG ratings tell you nothing about how sustainable the business model of a firm is, or about how sustainable its products and services are. What they tell you is whether the company ticks the boxes of reporting on its own corporate conduct. There is no link, and I mean it, no link between a company’s corporate business growth strategy and their sustainability ratings.

Whoever views the current ESG ratings as nothing more than an annual indicator on corporate conduct, and nothing more than that, is right. And for the rest, and for the companies themselves, they shouldn’t even look at the ESG ratings. They are not only misleading, but also costly. It costs a lot to have access to these ratings, and if you are running a company, well, then you will find yourself reporting on a zillion indicators that do not mean a single thing for the investor who is making the investment decisions. An absurd reporting task bound to discourage anyone working with it.

As ESG ratings are constructed today, they give you a false and, in many ways, severely incomplete picture of how sustainable the business model of a company is.?At the same time, I do understand why they are used. The financial industry loves lazy scalable solutions, the ones you can lean on without taking any responsibility. “This company has been given an A-rating by XXXX.” But that very company might be depleting natural resources faster than the Silicon Valley tech guys are playing the roulette in Vegas. The financial industry loves to pretend that it all makes sense as long it does not impact the real intent with the investments, and that is to make money and a lot of it. If it is packed as sustainable, very fine. “We have external ratings we use for informing our investments decisions”. Sayonara, Goodbye, Arrivederci, Hejd?. Time to move on. For real.

Finding the centre of gravity

The real thing, the thing that makes a hell of difference (and of course requires time, effort and resources) is called ESG analysis.

Most of the ESG data we have access to today is self-published by companies. It’s only very seldom verified by a 3rd party and do not – in 99% of the cases – include any alternative data-sets that could be remotely interesting for an investor. It is plain-vanilla ESG data, minus the vanilla.

What is the centre of gravity for sustainable business? Where does it really make a difference for a company, move mountains, break chains, disrupt and evolve capacities? Well, to find this centre of gravity you will need some very daring people who questions the conformity of the current financial thinking as well as the current sustainability thinking, which by the way is dominated by the Anglo-Saxon world view.

Where do you find these people? Certainly not in the chain-of-command know-your-place structures of the big banks and asset managers where you have to keep your mouth shut (even if you are 200% right) in order not to upset the boss or the boss’s boss and jeopardise the next bonus and your upcoming promotion which will enable you to purchase that property which will impress your peers (even though, and you already know it, it will not make you any happier). These people, whatever they do, will never evolve the current systems which they are so dependent on. Never.

Instead, they go to fancy high-moral take-a-selfie-and-post-it-on-LinkedIn conferences where they praise Human Rights and participate in debates on the climate emergency (they might even make pledges while their at it). But deep down inside, when they close their eyes, they know... All of it is just nice to have, nothing more than that. A “highly rewarding” conference in Barcelona or London. Yeah, people are dying of severe hunger in big parts of Africa, but “we are proud to announce that we now will do Human Right due diligence in our investments and we take a lead on engaging companies in these issues”. It makes me ill, physically.?

The world we are experiencing, more and more merely as passengers on the train, will reshape the fundamental perceptions of sustainable investing and shift focus from corporate conduct to the real centre of gravity of suitability within the business. And this is a story that has still not been told. Yes, there are diamonds in the dark and sparks of light, but we have not seen the dawn yet. But we will. Because we have a choice.

The dusk of current ESG ratings

Earlier this fall, Senator Pat Toomey, a ranking member of the U.S. Senate Banking Committee, sent letters to ESG ratings agencies asking for clarity and transparency around the way we score companies. These letters arrived as state treasurers across the U.S. started pulling assets from asset managers with strong ESG commitments, criticizing them for prioritizing ESG concerns over shareholder returns.

ESG is the devil. That, at least, is what Elon Musk thinks (or what he tweets he thinks). That view might be a little extreme, but he’s right that there is something wrong with both the concept (investing with a view to environmental, social and governance factors) and its implementation.

Fund managers have long said that if you follow the ESG rules, you can’t help but win: You’ll make money and you’ll feel good too. It’s looking like they’re wrong.

Look at it through the lens of the World Cup. Of the 32 countries playing in this year’s tournament, host nation Qatar ranks 24th in ESG terms, as measured by asset manager M&G Plc. It scores badly on political rights, civil liberties, the treatment of migrant workers and environmental risks. But it does pretty well on rule of law, poverty and inequality reduction, and social stability.

Read more here.

Now onto some other ESG stories…

ESG investing in ASEAN

Relative to global developed markets, ESG analytics in the Association of Southeast Asian Nations (ASEAN) region is at an early stage of development. A key challenge is the availability of company ESG-related data and disclosures. Moreover, existing ESG research largely focuses on ASEAN benchmark index names. A unique sustainable investment framework is required to mitigate these challenges. Read more.

ESG Is Taking Over the Loan Market

Ethical debt deals are set to become the majority in Europe’s market for corporate loans for the first time next year. Bankers expect at least half of the loan deals for investment-grade firms in Europe, the Middle East and Africa to be tied to environmental, social and governance targets in 2023, based on interviews conducted by Bloomberg. That’s a jump from an already record 36% share this year, as pressure grows for firms to show investors their sustainability credentials. Read more.

Energy CEOs Hit Mute Button on ESG, Hinting at Fading Interest

The top bosses of US oil and gas companies are speaking less and less about climate and carbon emissions, a signal that the industry’s public focus on ESG over the past couple of years may be fading. That, at least, is according to a Bloomberg analysis of quarterly conference calls held by 172 American oil and gas companies. The data shows how terms such as “climate change”, “energy transition” and “net zero” have come up with gradually less frequency in the most recent rounds of conversations with analysts and investors. Read more.

Understanding the Role of ESG and Stakeholder Governance Within the Framework of Fiduciary Duties

Over the past decade, investors, companies, and commentators have increasingly accepted and adopted stakeholder governance as the way to pursue the proper purpose of the corporation and have embraced consideration of ESG issues in corporate decision-making toward that end. But an emerging movement opposed to any consideration, at all, of ESG factors threatens to erase the gains that have been made over the past ten years and revert to the outdated view that the purpose of a company is solely to maximize short-term shareholder profits. Read more.

The World Needs a New Planetary Politics

The planet is in the midst of an environmental emergency, and the world is only tinkering at the margins. Humanity’s addiction to fossil fuels and voracious appetite for natural resources are accelerating climate change and degrading ecosystems on land and sea, threatening the integrity of the biosphere and thus the survival of our own species. Given these risks, it is shocking that the multilateral system has failed to respond more forcefully. Read more.

With that, have a great non-ESG-rating week!

Kind regards,

Sasja

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