Washington - In late May, SEC Chair Jay Clayton warned investors about the misleading nature of ESG ratings.
Clayton said the true ESG rating process involves inconsistent metrics by which ratings agencies come to their conclusions. In his view, the lack of a standard for companies disclosing their environmental, social, and governance (ESG) data forces ratings agencies to rank companies on differing metrics. When companies lack a universal standard for their publicly available ESG information, there can be no real basis to fully compare their efforts. As a result, ratings agencies are forced to use limited information, making ratings imprecise and inconsistent.
"I have not seen circumstances where combining an analysis of E, S and G together, across a broad range of companies, for example with a 'rating' or 'score'... would facilitate meaningful investment analysis," Clayton said.1
Raising similar concerns is the recent greenwashing trend that the existence of ESG ratings has instigated among companies, as noted in a recent article in the Financial Times.2 To adhere to the ongoing investor pressures to align with ESG initiatives, some companies may disclose disingenuous information solely to attract more capital from investors and be green-lighted by ratings agencies, with little action backing their words.
At a time when ESG investing is attracting so much positive attention, the industry cannot allow for misleading ratings and flawed institutional morale to cloud the momentum that has been gained.
Thus, there is a strong incentive for companies to be seen as addressing these issues, as evidenced by the fact that investors seem to be demanding the data in increasing numbers. In the wake of growing fears about climate change effects and COVID-19, and increased awareness of issues regarding racism and inequality, $31 billion has been poured into ESG strategies between January 2019 and March 2020, bringing the total to $119.3 billion allocated to ESG funds up to that date.3 With such financial backing, the ESG industry holds tremendous power and responsibility.
How Calvert's research process seeks to hedge risk against inconsistencies
Clayton's comments on ESG ratings are not surprising. Calvert President and CEO John Streur told the Senate Committee on Banking, Housing and Urban Affairs in April 2019 that: "When it comes to the issue of standardizing disclosures related to ESG risk factors, we are behind many other developed economies around the globe ... Much of the information provided through voluntary disclosures is difficult to compare and inconsistent across issuers, resulting in considerable costs and resource expenditure for investors."4
Calvert's awareness of these flaws within ESG ratings - reporting inconsistent data points and greenwashing tendencies among companies - has prompted us to take actionable steps to dive deeper than surface-level ratings in our screening processes. By utilizing an exclusive bottom-up research approach when examining companies' ESG exposures, Calvert seeks to hedge future financial risk by building custom scorecards based on key performance indicators (KPIs) when ratings reports lack significant insights. Calvert's analysis of KPIs helps us determine the financial materiality of ESG issues within the companies we analyze, giving us the ability to make educated predictions on how ESG exposures will impact a company's future financial performance. Calvert notes that there is a diversity of financial materiality among different industries. Therefore, we sort companies into peer groups based on common ESG risks and rank them next to their peers, equipping us make investment decisions based on our determination of industry leaders and laggards.
Finally, to push companies to a more universal standard, Calvert's engagement team works with reporting companies, government agencies and advocacy groups to encourage improved operational practices and reporting standards across industries.
Bottom line: Calvert agrees with the SEC that inconsistent rating metrics and greenwashing across the ESG industry are real concerns that need to be addressed. For our part, Calvert performs our own research to foster consistent scoring metrics across companies within particular subindustries, and works with industry coalitions, government agencies and advocacy groups to encourage companies to adhere to a universal operational and reporting standard.