“Trustees relying on a headline ESG rating ARE at risk.” – pI ESG Club Conference 2023 Recap

The following is a write-up by Integrum ESG analyst Molly Frazer after having attended Portfolio Institutional’s ESG Club Conference on 13 September 2023. This was an event attended by many leading figures in the UK & EU Asset Owner community, where institutional investors engaged on how to reduce the world’s reliance on fossil fuels, protect the ecosystem, and promote greater equality. 

Last week my colleagues and I had the privilege of attending the ESG Club Conference, hosted by Portfolio Institutional. With so many experts and industry leaders in the crowd, there were a lot of insights to take away and unpack from this event – which I have helpfully summarised below. 

“How can people trust ESG ratings they don’t understand?” 

During the event, our CEO Shai participated in a panel discussion focused on the question of whether investors can place trust in ESG ratings and take them seriously. 

Notably, he addressed questions related to data gaps and the utilisation of proxy or ‘guesstimated’ data. He emphasised the risks associated with this common practice, despite the demand for estimates to fill data gaps.  

The argument against using estimated data is centred around the idea that “no disclosure is valuable data”; if an investor utilises a narrow materiality framework, which is sector-specific, there is little justification for a company failing to report on all the significant ESG issues within that framework.  

The data gap should then instead serve as a warning signal to investors, suggesting that companies may not be taking material ESG risks seriously or could be concealing vital information. Hence, estimates provide a false sense of reassurance and do not offer investors an accurate depiction of the situation. 

He also delved into the issue of the lack of correlation between ESG ratings offered by different rating providers, and whether this disparity undermines their credibility. He noted that ESG ratings encompass a wide spectrum of factors, unlike credit ratings, which accounts for the variability in these assessments.  

Likewise, while there is a growing consensus regarding what the material ESG metrics for individual companies are, there remains a lack of consensus on the level of materiality associated with these metrics. These materiality weightings vary from one ratings provider to the other. As such, this, too, contributes to the divergence in ratings.  

The lack of correlation between ESG ratings should therefore not deem them as ‘’not fit for purpose’, and we are still able to take these ratings seriously.  

The question we should instead ask, is why are people taking ratings which they don’t understand seriously? Investors need to see the underlying data behind these ratings to explain the scores. Transparency around methodology and reason for score should therefore be a key priority for EGS ratings providers.  

Similarly, depending solely on a single ESG ratings provider does not constitute effective risk management; given the intricate and multifaceted nature of ESG considerations, it is imperative to seek broader coverage of companies to obtain a more comprehensive and well-rounded assessment of each company’s ESG profile. 

Net zero, Biodiversity & the ‘S’ in ESG 

The other three panel discussions also provided many invaluable insights. On the discussion of transition assets and the net zero pathway, it was emphasised that public markets are not going to be able to solve the issue on their own, emphasising the need for clear, uniform regulation to drive progress in this area.  

However, for this to be achieved, asset owners have a responsibility to engage with policymakers and act as a catalyst. The discussion ended on some positive notes around progress in hard-to-abate industries, where despite green technology not yet being commercially viable, the abundance in the options and of green technology in these industries is something to be optimistic about. Examples include clinker substitution, scrap-based steel, and the re-use of slag and fly ash 

The panel discussion on biodiversity was less optimistic, beginning with the claim that there is no silver bullet when it comes to measuring biodiversity loss, acting as a significant challenge when it comes to tackling this issue.  

Nonetheless, we do not need perfection in data to start trying to reverse biodiversity loss. Data points already exist (namely on ‘potentially disappeared fraction’ (PDF) or the ‘mean species abundance’ (MSA)) which can be used as a starting point. We need to act now, as we don’t have time to wait for the perfect data set. 

The final discussion was on the ‘S’ of ESG. While in environmental issues we can think about ‘offsets’ to counter poor behaviour in one area (such as investing in reforestation to make up for unavoidable emissions in operations), this cannot be the same for social issues. Providing a universal living wage for your employees does not negate the poor treatment of a company’s tier 2 supplier workforce.  

As such, human rights due diligence should be a key precursor to choosing an investee company, whereby the UN (United Nations) Global Compact should provide a baseline to investment decisions, and exclusions on companies who violate these very basic principles should be implemented. 

Action points for the future 

To conclude, the ESG Club Conference offered valuable insights into how to drive change in challenging times. There was a re-emphasis on the need for transparency in ESG ratings, with institutional investors calling for clarity in data and methodology. While discrepancies among ESG ratings were discussed, they don’t negate the importance of ratings but instead highlight the need for a comprehensive view through multiple rating providers. 

The discussions on transition assets, biodiversity, and social issues underscored ESG complexity; achieving a net-zero pathway and addressing biodiversity loss require collaboration amongst stakeholders; and the ‘S’ in ESG demands attention, with human rights due diligence being a vital requirement. 

The conference revealed a path forward in ESG investing; transparency, collaboration, and holistic approaches. Imperfect data shouldn’t hinder action on pressing environmental and social challenges. Asset owners and managers alike have the capacity and responsibility to shape a more sustainable and equitable future – act now!