The need for more consistent data around environmental, social and governance (ESG) scores is becoming ever more crucial as sustainable investing hits the mainstream.
ESG investing has exploded in recent years. Highlighting this, sustainable investments have surged 34% to over $30trn since 2016, according to the Global Sustainable Investment Alliance (GSIA).
This dramatic rise, however, has led to a proliferation of data providers all looking to catch a piece of the pie. According to Gianfranco Gianfrate, Professor of Finance at EDHEC Business School, there are around 200 providers of ESG data scores.
The huge number of data providers has led to a lack of consistency. There are a million-and-one-ways providers can score a company due to the subjective nature of ESG as a topic. For example, the two biggest providers, MSCI and Sustainalytics, have a correlation of just 0.5 on their ESG data scores.
“Because there are so many data providers [with such varying scores],” Gianfrate said at ETF Stream’s ESG Investors Forum event, “investors are able to find one that rates the sustainability of a company even the others do not. It is like having no ESG ratings at all.”
One impact from a lack of standardisation has been the rise of greenwashing – the practice of making a misleading claim about the sustainable benefits of a product.
Last November, SCM Direct, the wealth manager run by Alan and Gina Miller, called on the Financial Conduct Authority (FCA) to conduct a review of ethical strategies amid “widespread misclassification and mis-selling”.
SCM Direct found a number of ESG products including the L&G Future World ESG UK index and the Vanguard SRI European Stock fund had “significant” amounts of exposure to companies in tobacco, gambling and alcohol industries.
This is not the first time in 2019 Vanguard came under fire for having such stocks in its products. In August, the US giant removed as many as 29 stocks including gun manufacturer Sturm Ruger from the Vanguard ESG US Stock ETF and the Vanguard ESG International Stock ETF.
Detlef Glow, head of EMEA research at Lipper, said the lack of common language is a “significant” barrier to the growth of responsible investments and enables greenwashing.
While SCM Direct said in its report: “It is shameful that the investment industry is prepared to pay lip service to such considerations to gain assets and fees, and even more shameful that the UK regulator does not appear to have taken any action against firms greenwashing and thereby meet its strategic objective to ensure that markets function well and its operational objective to protect consumers.”
Steps are being taken by regulators to tackle the issue of greenwashing by introducing stricter rules around ESG standards.
Last June, the EU Commission introduced new disclosure requirements earlier this year related to sustainable investments. The regulation was implemented around three pillars; the elimination of greenwashing, regulatory neutrality and a level playing field for all investors.
While in the UK, the FCA has said assessing whether products are greenwashing will be an active area of focus.
Glow commented: “The initiatives…will help to align the communication around sustainable practices and investing.
“Nevertheless, even as these new standards are a step in the right direction, it is already clear that they will not be sufficient to eliminate all hindrances and greenwashing, so that it is foreseeable that these standards will be extended in the future.”
The issue is even more pertinent in the ETF space. The uptake of ESG ETPs exploded in 2019 with assets doubling from $23bn at the start of the year to over $50bn.
However, the lack of standardisation between the different ESG providers is proving to be a headache for investors.
As Matt Brennan, head of passive portfolios at AJ Bell, said, one of the main advantages of ETFs is transparency, however, ESG ratings are effectively “black boxes with little disclosed on how they are calculated”.
“If ESG ratings are to become a mainstream part of the ETF infrastructure, we would push for greater disclosure on how they are calculated,” Brennan concluded.
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