Article originally published on Curation
The OECD also questioned whether current ESG ratings are “fit for purpose” due to “inconsistencies” and called for improved coordination and transparency. The organisation earlier warned that the variability of ESG ratings, depending on the chosen provider, strengthens the argument for sector regulation. (Responsible Investor)
Why does this matter?
ESG concerns play a vital role in a company’s long-term financial resilience, but inaccurate ESG ratings fail to convey this vital information to investors.
Where have we seen this before?
Other reports have reached similar conclusions as the OECD – a study last year found that a “quantity bias effect” exists within ESG data, with a correlation between the level of ESG data disclosure and MSCI’s ESG ratings.
When examining the methodology behind MSCI ESG ratings, Bloomberg Businessweek found that, instead of measuring the impact a company has on the Earth and society, ESG ratings measure the risk the world poses to the company. For instance, despite McDonalds’s producing 54 million tons of CO2 emissions in 2019, MSCI upgraded its rating after determining climate change did not pose a risk to the firm’s profits.
Lack of correlation
Various ESG ratings providers have differing methodologies, and this can be reflected in the low levels of correlation between the ratings they provide. MIT research found the correlation between six major ESG ratings agencies, including MSCI, Moody’s and Refinitiv, to be 0.61 (with 1.00 representing a perfect correlation and -1.00 a perfect negative correlation). In comparison, the three largest credit ratings agencies are correlated between 0.94-0.96 on their debt ratings.
This divergence not only creates confusion for sustainable investors, but could also dampen firms’ motivation to improve their ESG performance, since it is not clear what they should focus on.