ESG scores ‘uncorrelated’ to companies’ behaviour, academic claims

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Environmental, social and governance scores are not correlated to a company’s environmental or labour practices, an academic at the London School of Economics has found. If true, this has big implications for the positions taken by ESG investment funds which rely on such scores. Can scheme members trust asset managers to drill into the companies they invest in? 
 
ESG is everywhere in the investment industry, and fund managers are scrambling to show that they take these risks into account. While some houses have long-standing and large ESG teams that create bespoke ESG scores, others rely on external information, for example by ratings agencies. 
 

ESG scores rely on ‘soft’ data 

 
Greenwashing has long been a concern for investors. Aneesh Raghunandan, an assistant professor of accounting at the London School of Economics, has made it his field of research to see whether such ESG claims are “legit” on average. 
 
Raghunandan said there are two forms of ESG-related information about investee firms – ‘hard’ information showing what companies are doing regarding carbon emissions, or their track record with stakeholders such as employees or customers. “Then there is soft information. Companies say nice, soft and fuzzy things but you can’t verify them,” he said. Many products rely on ESG scores, he noted, but “the problem is they tend to rely on soft information”. 
 
He claimed that ESG funds tend to “pick firms with higher infringements” in areas like the environment, safety and labour. “There is no correlation between the ESG rating and what they are up to,” he said. As an example, he gave clothing firm Boohoo, which he said “was included in pretty much every major ESG fund, because they had great scores” based on the firm’s own messaging or ‘soft’ information. 
 
Among FTSE350 firms, violating companies underperform in the stock market and are less profitable than their non-violating peers, he also found. 
 

Violation Tracker aims to improve information on company infringements 

 
Initiatives like the newly launched Violation Tracker UK, can help address the information gap when it comes to companies’ actual ESG track record, said Raghunandan. 
 
The tracker is the UK version – instigated by UK campaigners the Transparency Task Force – of an existing US website by campaign group Good Jobs First, which also created the UK site. The Violation Trackers record regulatory penalties given to companies in the two respective jurisdictions. The creators of the databases plan to build a multi-country dataset including large listed companies, which could provide infringement data to the investment world.  
 
However, analysis of the underlying firms of UK-based ESG funds against this hard data is prevented by the lack of disclosure requirements in the UK, said Raghunandan; in the US, mutual funds have to show their positions – with a time lag – multiple times a year. 
 
To create more transparency and greater accountability of ESG funds, he said it would be a good idea to put pressure on regulators to mandate disclosure, even though he said “there would be push-back".

EU to centralise companies' regulatory information in new public database


The European Commission has recently published proposals for a European Single Access Point "providing centralised access to publicly available information of relevance to financial services, capital markets and sustainability". Under the proposals, companies will have to electronically submit all information they have to make public under existing EU regulations so they can be easily retrieved. ESAP will have a search function, machine translation and allow users to extract the information, and allow voluntary disclosure by small or unlisted firms.

The EC said the ESAP will help promote a data-driven finance system, seeing sustainable finance as key to achieve the green transition of the EU economy.
   
The European Fund and Asset Management Association said the proposal for ESAP were a crucial step in addressing the limited availability and scattered nature of financial and sustainability-related entity information at EU level, claiming that only 5% of EU financial reporting obligations are currently machine-readable.

Tanguy van de Werve, director general of EFAMA, said: “The consolidation of publicly disclosed financial and ESG company information in a single place would greatly contribute to the integration of EU´s capital market and save investors time and resources, notably by giving them free access to such data in a structured, comparable and machine-readable format.”
   
   
 
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