The lack of convergence in corporate sustainability scores from different providers is a well-documented problem and one that continues to make investors uneasy, according to a new report on ESG scores from Scope Research.
However, the divergence is deeper rooted than just the lack of good data. The varying environmental, social and governance (ESG) scores from leading providers reflect a fundamental difference between financial and non-financial ratings.
Unsurprisingly, investors of course want reliable, comparable assessments like credit ratings which as Diane Menville, head of ESG at Scope Group and one of the authors of the report, says “essentially answers one question: what is the probability of default of a debtor?”
She adds, “An ESG score is different. There is no single comparable question. Indeed, investors and issuers today are asking a range of different questions as sustainable investing balloons into a $40trn sector.”
The report believes that an answer for investors is to adjust their expectations and accept that double, if not multiple, ESG scores may be necessary to capture fully the sustainability of their investments
Some corporate ESG scores assess the ESG-related risks companies face such as natural disasters, climate change, regulatory penalties or the danger of stranded assets like oil fields and coal mines.
Others measure the impacts of the company itself on the environment and society. No single score can capture so-called double materiality: the balance of risks and impacts.
As the report notes, the result is that providers of ESG assessments rely on multiple different criteria, inevitably leading to different results.
“The complexity of measuring sustainability, in contrast with creditworthiness, comes into sharper relief when it becomes clear that the ESG risks and impacts of a company extend far beyond its own activities to those of its suppliers and customers: the supply chain,” says Menville.
A credit rating is also an absolute measure. However, investors seeking to balance risk, reward and sustainability, might want a score which shows how well a company rates compared with others in its sector – “best in class” – rather than in absolute terms.
There is also the problem of the data. “For now, there is no ESG disclosure equivalent to the audited financial statements of companies, based on internationally agreed accounting standards, on which credit rating agencies rely for assessing the likelihood of a borrower’s default on its debt,” says Menville.
The report points to standardisation being on its way, notably in Europe. The European Commission’s new Corporate Sustainability Reporting Directive (CSRD), a replacement for the Non-Financial Reporting Directive (NFRD), strengthens rules to ensure that Europe’s biggest companies report reliable and comparable sustainability information.
However, it is early days. “We would not be surprised to see more institutional investors use standardised data to create their own bespoke ESG scores to meet the different demands and sensitivities of their clients. Divergence might yet be a sign of competitive advantage,” says Menville.
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