Biodiversity is increasingly becoming a priority for investors as they study the impacts of a company’s nature-related impacts, even as standards on such information are lacking, according to a report from Moody’s.
A major stock index that tracks sustainable investments dropped electric vehicle-maker Tesla from its list in May 2022 – but it kept oil giant ExxonMobil. That move by the S&P 500 ESG Index has set off a roiling debate over the value of ESG ratings.
ESG stands for environmental, social and governance, and ESG ratings are meant to gauge companies’ performance in those areas. Aboutone-third of all investments under management use ESG criteria, yet many environmental problems continue to worsen. Tesla CEO Elon Musk called the ratings “a scam,” and the U.S. Securities and Exchange Commission is discussing whether to propose new ESG disclosure rules.
The Conversation asked Tom Lyon, a business economics professor at the University of Michigan who studies sustainable investing, to explain what happened and how ESG ratings could be improved to better reflect investors’ expectations.
How does a company like Tesla, which makes electric vehicles, get dropped from the S&P 500 ESG index while Exxon is still there?
ESG ratings agencies typically rate companies against others within their industry, so oil and gas companies are rated separately from automotive companies or technology companies. Exxon stacks up fairly well relative to others in the oil and gas category on many measures. But if you compared Exxon to, say, Apple, Exxon would look terrible on its total greenhouse gas emissions.
Tesla may rate well on many environmental factors, but social and governance factors have been dragging the company down. S&P listed allegations of racial discrimination, poor working conditions at a Tesla factory and the company’s response to a federal safety investigation as reasons for dropping the company.
The way ESG criteria are measured also carries some biases. For example, the ratings consider a company’s direct greenhouse gas emissions but not its Scope 3 emissions – emissions from the use of its products. So Tesla doesn’t get as much credit as it might, and Exxon doesn’t get penalized as much as it might.
What can be done to make ESG investments better reflect investors’ expectations?
Another is for raters to stop trying to aggregate all of the different measures into a single rating.
Investors concerned about ESG often value different objectives – one investor may really care about human rights in South America while another is focused on climate change. When ESG ratings try to force all of those objectives into a single number, they obscure the fact that there are trade-offs.
ESG could be broken up so ratings instead focused on each piece individually.
Environmental issues tend to have a lot of available data, which make E the easiest category to rate in a consistent way. For example, scientific data is available on the increased health risks a person faces when exposed to benzene. The EPA’s Toxic Release Inventory shows how much benzene various manufacturing facilities release. It’s then possible to create a toxicity-weighted exposure measure for benzene and other toxic chemicals. A similar measure can be created for air pollution.
Social issues and governance issues are much harder to aggregate up into single ratings. Within the G category, for example, how do you aggregate diversity in the board room with whether the CEO personally appointed all the board members? They are capturing fundamentally different things.
To me, that’s the most egregious failure in the ESG domain. But we don’t have the data to track this behavior adequately, since Congress has not required disclosure of all types of political spending, especially so-called “dark money” from super PACs.
A few organizations are gathering more detailed information on specific issues. InfluenceMap, for example, invests an enormous amount of time looking at companies’ annual reports, tax filings, press releases, advertisements and any information about lobbying and campaign spending to rate them. It gave ExxonMobil a grade of D- for its political action on climate.
What can investors looking for positive impact do if ESG ratings aren’t the answer?
Investors can always take a more targeted approach and invest in specific categories that they believe will provide essential solutions for the future. For example, if climate change is their leading concern, that may mean investing in wind and solar power or electric vehicles.
There’s also a larger question in the background of all of this: Is investment pressure really what’s going to drive us toward a more sustainable future?
If you want to make a difference, consider spending time working with activist groups or groups that support democracy, because without public pressure and democracy, countries aren’t likely to make good environmental decisions.
Financial institutions around the world can now measure the positive impact of their investments into biodiversity conservation, adaptation, mitigation, forest protection and sustainable livelihoods with the help of a new indicator directory and resources platform, launched today.
The Land Use Finance Impact Hub and its Positive Impact Indicators Directory – launched today by UN Environment Programme (UNEP) Climate Finance Unit and the UNEP World Conservation Monitoring Centre (UNEP-WCMC) – has been developed with and for impact funds and sustainably focused financial institutions, and aims to support the rollout of effective industry frameworks to track the environmental and social impacts of land-use investments.
Aviva Investors, the global asset management business of Aviva plc, announced today the launch of two new equity funds in its Aviva Investors Sustainable Transition range, aiming to invest in companies that are managing their social and environmental impacts and providing solutions to support the transition to a sustainable future. Key areas of focus of the new funds include addressing social inequality and biodiversity loss, and the funds align with several of the UN Sustainable Development Goals (SDGs).
Infrastructure and real estate present varying ESG risks to institutional investors, but there are still opportunities to fund environmentally and socially responsible construction projects that offer acceptable returns.
Global investment professional association CFA Institute announced today the publication of Global ESG Disclosure Standards for Investment Products, the first voluntary set of reporting standards for the investment industry, aimed at providing transparency and comparability of investment products with ESG-related features.
Generation Investment Management, a sustainability-focused investment firm chaired by former U.S. Vice President Al Gore, announced the launch of Just Climate, a new climate solutions-focused investment business.