Beware The Wild World Of ESG Data
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Investors increasingly focus on company and fund sustainability as part of their investment process. BlackRock’s

BLK
CEO Larry Fink has led the charge- “We focus on sustainability not because we are environmentalists, but because we are capitalists,” he recently wrote.

Suddenly, all kinds of ESG funds focused on sustainability are popping up, with more than $1 trillion now invested in this format.

But the push goes far beyond investment format of ESG funds—to the overall public including stakeholders such as consumers and investors and employees—all wanting to know how companies compare on sustainability criteria.

It is not enough for firms to say they are sustainable—they have to prove it. But ESG data is sparse, and reporting frameworks are woefully inconsistent.

In a recent study released by the University of Zurich entitled, “Aggregate Confusion: The Divergence of ESG Ratings” the authors decomposed the divergence of ESG ratings from six prominent rating agencies into three sources: different scope of categories, different measurement of categories, and different weights of categories. They found the ESG ratings differed substantially (average correlation between the ratings on average only 0.54). In addition, they detected a “rater effect” where a rater’s overall view of a firm influenced the assessment of specific categories. They concluded ambiguity around ESG ratings represents a challenge for decision-makers trying to contribute to an environmentally sustainable and socially just economy.

So understandably, in this environment, companies are scrambling for ways to collect and aggregate sustainability data for their stakeholders. As one information point, MSC

SC


MSCI
I has indicated that sustainability is their fastest growing business segment. Sustainability software is experiencing a boom.

Buying data platforms is one approach being taken by large companies to help meet their sustainability data needs. In June 2021, JP Morgan bought ESG startup OpenInvest, followed by Blackstone’s

BX
acquisition of sustainability software Sphera for $1.4 billion a few months later. And so far this year, IBM

IBM
acquired environmental data startup Envizi and SAP launched several new products enhancing its sustainability capabilities.

We also see many companies building their own data platforms. Some asset managers, who have the double challenge of their company sustainability footprint as well as their investment portfolio sustainability, have opted to develop their own internal measurement of their company carbon footprint using government data, and then buy carbon credits. This seems a practical beginning approach at the company level, allowing for time to adapt to the changing environment. They next turn to their investment portfolios.

For asset managers, developing an approach for their investment portfolios can be more problematic, with the complexity increasing significantly from publics to privates. An in-house approach to evaluating portfolios may be a temporary fix, as clients typically require an independent check on methodology. And there is also the considerable data cost and the probable cost of having to redesign the in-house approach to meet evolving global standards. So asset managers look externally—

I. On the public security side, many are turning to external sources. Arabesque, Covalence, Ethos, Inrate, Sustainalytics, and Goby are just a few companies that offer comprehensive ESG data services. Each of these firms has its own technique for assessing ESG aspects, grading methodology, and risk analysis tools. The ESG data companies are often well-credentialed, with impressive brochures speaking of “thousands of data sources”—but the underlying methodologies for rankings may seem less than rigorous in this quickly evolving space.

  • As one example, an asset manager might retain an ESG data service company to rate a portfolio of stocks that a client has requested meet twelve of the seventeen United Nations Sustainable Development Goals, including “Emissions” and “Resource Use” in Environment, “Diversity” and “Labor Rights” in Social, and “Business Ethics” and “Capital Structure” in Governance. The data service company will provide a score for each metric for each stock in the portfolio, with an average score, and the asset manager can choose to divest the lowest-rated stocks.

II. On the private security side, data is even more problematic.

  • In one leading development, competitors are coming together to cooperate in building benchmark standards in the Data Convergence Project (DCP) being led by CalPERS, Carlyle, and Boston Consulting Group.
  • DCP is focused on private company data in underlying portfolio companies and is gathering such information as Scope 1, Scope 2 and Scope 3 emissions as well as statistics on board diversity and employee turnover.

ESG protocols are neither well-defined nor well-regulated. Can we collect accurate and consistent data to develop information to get environmental, social and corporate governance right?

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