ESG ratings: Present problems and future solutions

Diverging criteria often leads to confusion, experts warn

The proliferation of different ESG metrics and ratings has accelerated in recent years, allowing investors to analyse opportunities in ways that were previously impossible. James Baxter-Derrington talks to ESG investment specialists about current issues in the ESG ratings market and how the market might look in years to come.

Back in May, researchers from MIT Sloan and the University of Zurich published their paper Aggregate Confusion: The Divergence of ESG Ratings, that concluded, among other things, that "the level of disagreement [between ratings] is so severe that ratings agencies reach not just different, but opposite conclusions".

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One of the main factors they attributed this divergence to was "rater-specific bias" driven by both "differences in opinions" and "disagreements about underlying data".

While many in the industry believe "diversity of views is a good thing" others argue "there is a need for greater harmonisation" and that there now exists an "oversaturation of different ESG scores".

Ratings disparity 

Hortense Bioy, director, sustainability research EMEA and APAC at Morningstar, described the proliferation of ESG ratings as "a challenge for investors" for whom it is "crucial [to] understand the approach taken by the [ratings] provider/asset manager".

However, she added this lack of correlation "presents an opening for active investors to deliver for clients - particularly those investment firms with proprietary research capabilities".

Bioy also argued that "more uniform ESG ratings would not necessarily be a good outcome for investors" because "diversity of views is a good thing".

She reasoned: "You would not expect stockbrokers to issue the same buy/sell recommendations, so why would you expect ESG ratings to send the same signals?"

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This disparity in ratings is also "not a major issue" for Kenza Himmi, responsible investment analyst at Mirabaud Asset Management, who argued it "raises different points which analysts can use to dig deeper on a company", and added investors should be encouraged to look around for other ESG scores but "be wary at the same time".

A common framework and disruption

However, the proliferation of ESG metrics and providers has seen various industry commentators call for a "common ESG analysis framework" to allow for "comparability and consistency of ESG data", a conclusion also drawn by the MIT Sloan/University of Zurich paper.

The paper broke down the indicators of ESG performance from six ratings providers (Vigeo Eiris, RobecoSAM, MSCI, Sustainalytics, Asset4 and KLD) and found 709 individual indicators across 65 different categories ranging from 282 individual indicators at one end of the scale to 38 at the other, which demonstrated "how and why different raters assess the same company in different ways".

Julie Moret, global head of ESG at Franklin Templeton, agreed there is an "oversaturation" of ESG scores in the market, the 'lion's share" of which still resides with two to three industry players.

She expects this market to be disrupted amid "a growing number of new entrants into the market, especially from fintech or artificial intelligence (AI) data disruptors".