ESG News OECD CALLS FOR ESG RATINGS ADJUSTMENT
Sustainability scores should focus on emissions due to their wide-ranging implications. Andrew Holt looks at the report.
The Organisation for Economic Co-operation and Develop- ment (OECD) believes that ESG ratings should focus more on CO₂ and other climate-destroying emissions and less on the disclosure of corporate policy and objectives. On what it calls “improving the alignment of the environmen- tal pillar of ESG ratings with a low-carbon transition”, a report published by the organisation stated: “Inconsistencies in the construction of ESG ratings across providers, the multitude of different metrics measured in one E pillar score, and insuffi- cient quality of forward looking metrics prevent them from supplying consistent and comparable information on transi- tion risks and opportunities across firms and jurisdictions.” Notably, it added: “Rating providers appear to place less weight on negative environmental impacts while placing greater weight on the disclosure of climate-related corporate policies and targets, with limited assessment as to the quality or impact of such strategies. Such limitations could hinder the use of E pillar scores by investors with an aim to align portfolios with the low-carbon transition.” “Greater transparency and precision of the meaning of sub-cat- egory scores and metrics could contribute to better alignment of ‘E pillar’ scores with a specific purpose, such as to assess cli- mate transition risks and opportunities, or broader environ- mental impacts,” the report read. “Such clarity would allow investors with specific sustainability goals to use ESG approaches as a more effective tool for portfo- lio rebalancing and risk management,” it suggested. In reply, Dr Richard Mattison, president of S&P Global Sustain- able, said: “Climate is an essential element of an ESG score but not the only element. As reflected in the Sustainable Develop- ment Goals, all three pillars of ESG are key to securing a just transition to a net zero future.”
Authority impetus There is, within this shift in focus, a key role for regulatory bodies to shift the dial. “Financial market authorities could facilitate greater transparency on the high-level purpose of the environmental pillar by ESG rating providers so that market participants understand the extent to which their methodology aligns with long-term value and/or with climate related risks and opportunities,” the report read.
This, said the OECD, should include guidance from central banks, supervisors and financial market regulators on catego- ries of metrics and methodological good practices within the ‘E pillar’ and outline the extent to which these may be more or
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less relevant for climate-resilience. “In addition, clear bounda- ries should be defined as to which areas of the E pillar are rele- vant to long-term financial value,” the report added. This is a clear call to arms for market authorities to play their part in transforming ESG ratings.
It also comes on the back of the International Organisation of Securities Commissions (IOSCO) calling in November for ESG ratings and data providers to come under regulatory oversight.
The OECD also calls for a strengthening in the comparability of ESG rating and investing approaches and improving the quality of data used for investment decisions. Here the report stated: “ESG ratings often lack transparency in their calcula- tion and differ substantially in the metrics on which they draw, as well as the methodologies used in their calculation, raising questions as to the extent to which their aggregation contrib- utes to long-term value. “Methodologies tend to differ substantially across rating pro- viders, and result in a lack of correlation between ESG ratings supplied by different providers,” the report added. “Therefore,” it noted, “policies are needed to ensure global transparency, comparability and quality of core ESG metrics in reporting frameworks, ratings, and definitions of ESG investment approaches.”
It has been cited on many occasions that ESG ratings provid- ers have differing methodologies, and this can be reflected in the low levels of correlation between the ratings they provide. Putting the case for the defence, Dr Mattison, said: “At present ESG disclosures by companies can be inconsistent, leading to data gaps that need to be interpreted in order to present the most comprehensive view available at that point in time. This is one factor that can lead to differences in ESG scores between score providers.”
Quantity bias
Other reports have reached similar conclusions as the OECD, noted Mubaasil Hassan, sustainable finance specialist at risk monitoring firm Curation. “A study last year found that a ‘quantity bias effect’ exists within ESG data, with a correlation between the level of ESG data disclosure and MSCI’s ESG rat- ings,” he said.
On a similarly concerning level, IOSCO has said potential conflicts of interest can arise since ESG ratings and data pro- viders may offer other services to companies relating to the ESG performance. The US Securities and Exchange Commis- sion also recently identified a conflict-of-interest risk in ESG products. In response, Dr Mattison added: “We consider ESG risks and ESG impact and take a balanced approach to this, and we are transparent – our methodology and weighting are avail- able in full on our public website.”
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