The standardisation of reporting ESG activities is one of the major issues for investors seeking to differentiate ESG performance between different companies, assets and sectors.
The problem stems from the broad differentiation in factors involved in organisation’s ESG rating and performances.
For example, the elements driving the ESG rating of a technology company may revolve around working conditions and an ethical supply chain whereas the ESG rating of a sovereign bond may relate to the efforts of that government to control greenhouse emissions.
Compounding challenges with a lack of standardisation between different companies and asset classes, the organisations producing ratings and research on ESG have wildly different measurement methods.
Asset managers may have internal methods of measuring ESG but while these methods may be useful for portfolio managers receiving regular research from their inhouse analysts, this same portfolio manager will struggle to make meaningful comparisons with external ESG ratings and research
This lack of standardisation creates a significant level of uncertainty around what a true measure of ESG performance is, and ultimately which activities and outcomes can be classed as ESG.
It may be that over the long term that different providers of ESG measurements or research create a competitive advantage by having a preferential model, but in the short terms it may create scepticism around ESG.
Currently, it is likely there is a situation where investors may be presented with an ESG designated investment by one organisation that fails to meet the ESG standards of another.
Initially, this will create confusion but if the problem persists there is a risk greater adoption of environmental, social and governance investing is stifled.
Seeking out true impact investments provide an alternative to ESG investing due to the prerequisite of an impact investment needing to have a measurable positive impact, as opposed to a simple filtering out companies or activities deemed unethical.
This will be a key area of debate for the industry in 2020 and will form part of the conversation at the Impact Investing & Circular Economy Conference to be held in London.