The second roundtable in Linchpin’s Innovation series on 8th December took a look at recent developments in the area of ESG scoring. Our panel, moderated by Aoifinn Devitt, consisted of:
Luba Nikulina, MD and Head of Research at Willis Towers Watson
Aled Jones, Head of Sustainable Investment, Europe at FTSE Russell
Michelle King, Interim Head of Pensions, Lancashire County Pension Fund
Dr Tom Steffen, Quantitative Researcher at Osmosis Investment Management
Our panel started by agreeing that data scoring individual companies on their ESG attributes is still a young industry. The spotlight now being shone on it has been beneficial both for users and data providers in terms of improving the data and understanding what it means. Physical risks are rapidly becoming financial risks and that means robust data is all the more important to allocators.
All agreed that a level of auditing and standardisation would be helpful, but the point was made strongly that different scorers are using different methodologies and have different biases. It is not surprising that correlations between scores are low, much as investor analyst ratings will differ. Whilst standardisation is desirable, uniformity is not, and investors need to understand and buy into providers’ subjectivity, as otherwise companies can game the data.
One panel member commented that the data should be driven by what investors need to make their decisions. Public disclosure, as with financial data, would immediately create more transparency. In this context a member of the audience noted the recent announcement of and consultation on a possible Sustainability Standards Board under the IFRS Foundation.
The limitations of the current data were picked over: as an example, most data providers ignore scope 3 carbon emission data, which accounts for up to 85% of the total. Panellists argued for more granularity and believed that a single ‘score’ could not pick up the nuances. The view was also put that scoring the S and G was so different from the E that they could not sensibly be combined. One panellist used Tesla as an example: it may score well in terms of green emissions, but very badly on the S and the G.
The debate really started about how investors can and should use the data. Good stewardship and engagement is key, as is raising the bar, but the fact remains that most portfolios are consistent with a 3.5 degree rise in temperatures despite the ‘green-hoping’ for only 1.5 or 2 degrees.
The question was asked whether there was any correlation between ESG scores and outperformance using financial metrics. For example, should investors invest in poorly scoring companies in the hope of improving them? The response from the panel was that correlation today is limited, perhaps because of the data limitations and the fact that they are backwards looking. If allocators choose to invest in lower scoring companies, the panel emphasised the importance of putting effort into engagement.
This led to a further challenge from the audience whether passive managers could meaningfully engage with their large portfolios and still charge their very low fees, given engagement takes resources. The panel responded that a lot could be done through collaboration - here passive investors with their large holdings are important - and secondly that they could raise the bar generally. Some panellists said that lack of resource was no excuse for not exhibiting good stewardship, though there is of course cost associated with this. A member of the audience commented that if investors or managers choose to defer the risks by managing them financially rather than engaging with companies and aiming for real improvements, they are deferring rather than reducing the cost.
A third challenge came on how to score companies who either do not or cannot provide data, and whether providers should use private as well as public data. Some Emerging Market companies were seen as laggards in this respect. The general consensus was to mark companies down where data was not in the public domain but some exceptions were accepted, for example, data on ‘green revenue’ and maybe for smaller or younger companies who don’t necessarily have the resources to provide all the data.
We ended the roundtable with a general discussion on the need to focus on improving the outcome rather than ‘green-hoping’ or ‘green-wishing’. Higher quality data is a key part of that, but it will take a long time and asset allocators need to manage the expectations of their trustees, both on what can be achieved and how long it will take. A plea was made to include forward-looking data, as happens with earnings forecasts. It is almost inevitable that investors will have to choose to prioritise some aspects of ESG over others. The panellists thought that climate change was the most urgent but audience members reminded them that the view the other side of the Atlantic was quite different with investors there often expressly prioritising the S and the G.
Useful links and articles