Berg: ESG labels suffering from ‘very high’ measurement divergence
Key differences arise in weighting environmental impact
The fundamental issue affecting ESG labelling right now is a divergence in how much weighting should be given to each of the three ESG categories: environment, social and governance.
According to analysis undertaken by Florian Berg, a researcher at Massachusetts Institute of Technology’s Sloan School of Management, when assessing ratings providers such as Sustainalytics, Moody's, S&P and Refinitiv, the strongest correlations between the ratings agencies were for the environmental dimension and the lowest for the governance dimension.
However, the greatest divergences arose when environmental impact did not match social and governance considerations, for instance with tobacco companies receiving markedly different ratings between firms.
Of the research, Berg says: “Measurement divergence is very high, and that also indicates that we do not know how to measure certain things perfectly.”
One example given by Berg in divergence in approach to ESG was through nuclear energy. Berg recalled growing up in Germany around a large anti-nuclear movement, only to move to France as an adult and receive energy bills boasting of being 100% green, as the power had been derived from nuclear sources.
“Cultural differences will be reflected in ESG ratings”, says Berg.
The division in ESG labelling came to wider attention this year when electric car manufacturer Tesla was taken off the S&P 500’s ESG index due to concerns over social and governance issues while oil and gas giant ExxonMobil was left on, leaving Tesla CEO Elon Musk to describe ESG as a “scam”, and more recently, “the devil incarnate”.
But we should not forget that [ESG labelling] is not only about the operations of the company itself. It should also be about the risk that the company poses to their surroundings.
International efforts are also underway to establish ESG labelling schemes, with initiatives by the Financial Conduct Authority (FCA) in the UK, European Securities and Markets Authority (ESMA) in the EU, the Securities and Exchange Commission (SEC) in the US, and by the FSA in Japan to standardise and regulate the sector. Attention is being paid by all to the International Sustainability Standards Board (ISSB), founded in COP26 with the desire to maintain a common set of standards between jurisdictions.
Of the impact of these international schemes and the roles of the ISSB, Berg says: “The ISSB tries to focus on a minimum set of financial materiality, it's like version 2.0 of [Sustainability Accounting Standards Board] SASB in this regard. If everyone can get behind it in a lot of different jurisdictions, then this would be great for sure.
“But we should not forget that it's not only about the operations of the company itself. It should also be about the risk that the company poses to their surroundings, and I'm not so sure what the ISSB will capture here.”
Berg made the remarks at a “ESG Measurement and Impact- Future of Finance” webinar hosted by EDHEC Business School, based in France.
Speaking to Net Zero Investor, the FCA’s sustainable finance and stewardship lead, Mark Manning, commented on the authority’s proposed voluntary ESG code of conduct, and pressuring the UK central government for the power to regulate ESG labelling services.
