01 July 2019
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Two people can look at the same thing and conclude differently. We may have the same inputs but attach more significance to certain aspects than others. Maybe we apply our own values or interpret the data through the lens of a unique personal experience. Reasonable people can disagree, but in ESG investing, it's also time that we set an agreed minimum standard.
ESG factors have grown in importance to such an extent that today most investors are aware the moniker references environmental, social and governance factors. Yet the desire for simple ESG solutions has led to a divergence of some essential minimum standards. This lack of basic rules is now putting further progress at risk.
A small number of influential ESG data providers have emerged to provide ESG ratings to paying customers as a simple solution. These new ratings are being used to create ESG indexes and capital is being allocated according to their opinions. Whilst this provides strong evidence of how ESG has become mainstream, it also raises questions about the sustainability of the ESG environment that has been created.
Companies tell us that they find the volume of ESG questionnaires frustrating and confusing. They wrestle with complex real-world trade-offs but find these are not easily summarised into a tick-box approach. Nor do they find it obvious why diverse ESG issues, such as carbon or gender reporting, should be reported differently.
From the user's perspective, many wonder why material ESG data isn't being treated the same way as material financial data. Principles of fair disclosure should mean that no investor is disadvantaged - everybody has access to the same data at the same time. But when it comes to ESG data, much of it is hidden behind a pay-wall to the disadvantage of smaller investors.
The consolidation of ESG data providers has created a small number of highly influential firms that provokes justifiable comparison with the large index providers. Like them, their judgements can lead to the re-allocation of billions of dollars of capital and yet the ratings providers are typically subsidiaries of private companies with opaque governance structures and little public accountability.
There is much then that isn't sustainable about the environment we have created for ESG and ESG data. The consolidation of ESG data in favour of ‘ESG by numbers' means we are losing valuable space to discuss subjective questions. Opinions are being outsourced to data tick-boxing with frequently dubious governance. The time has come for a proper discussion about what a more sustainable ESG environment could look like.
Firstly, it is time for an ESG data charter to promote professional standards in the manipulation and presentation of ESG data. Compliance could be voluntary to begin with, but such a charter would address problems, like merging estimated and actual data in peer comparisons, and would boost confidence in the quality of the data upon which ratings opinions are ultimately based.
Secondly, we need a common system for ESG disclosure like traditional financial reporting. This would lower the cost of obtaining and comparing material ESG data and ensure fair access for all. It would also lower barriers for new ESG data providers to enter the market and hopefully encourage others with better governance structures.
Those of us who support ESG principles can be satisfied with the significant progress that has been made over the recent past. But it is somewhat ironic that a discipline so concerned with sustainability has arrived at a point where its own sustainability can be legitimately questioned. Others may have an alternative diagnosis and suggest different remedies, but the growing acceptance of ESG ideas means that it is an appropriate time for ESG practitioners to apply the same rigour to the agreed essentials of ESG as we do to our other professional activities. Hopefully on that, reasonable people can agree.
Jeremy Richardson is senior portfolio manager with the Global Equity team at RBC GAM
