What’s wrong with ESG ratings?
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Opinion

What’s wrong with ESG ratings?

Environmental, social and governance ratings are far from perfect – but criticism of the industry too often misses the mark.

Lucy Fitzgeorge-Parker ESG 1920px.jpg

According to Jay Clayton, chairman of the US Securities and Exchange Commission, they are “over-inclusive and imprecise.” Researchers at MIT Sloan characterized their effect as “aggregate confusion.” And on a recent Euromoney podcast, Peter Bakker of the World Business Council for Sustainable Development described them as “a bit of a zoo”.

These days, it can seem as though no one has a good word to say for environmental, social and governance (ESG) ratings. Are they really so unfit for purpose? And if so, why are investors still using them?

One of the main criticisms levelled at the industry is the wide divergence of ratings on offer from different providers. The MIT Sloan study, published last year, found that the average correlation between ESG ratings from six leading providers was 0.61. The researchers contrasted this with the 0.92 correlation between credit ratings provided by Moody’s and Standard & Poor’s.

This has been widely cited as evidence that ESG ratings are unfit for purpose – but such criticism misses the point in several respects.

Criticisms

For one thing, there is the question of whether it makes any sense to invite comparisons between credit ratings and their ESG counterparts.

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