Jane Genova
Jane Genova

Bloomberg Intelligence projects ESG (Environmental Social Governance) investments could exceed $41 trillion this year. Already they account for more than one-third of private capital under professional management.

What could put the brakes on that growth is the lack of standardization in how those investments are rated. Essentially it is a tower of babel. The myriad consultants out there issuing the ratings are using different methodologies and relying on different sets of data. There is also no guarantee that the data is accurate or comprehensive.

A sign of the growing concern about this issue is that diverse experts have been calling attention to it. They range from Alan Livsey in FT to lawyer John Quinn of Quinn Emanuel in Forbes.

Way back in 2017, McKinsey positioned sustainable investment as having progressed from “why” to “why not.” The management consulting firm also declared that asset type the new norm. More recently, in the January edition of Corporate Counsel, law firm Paul Weiss’ chairperson Brad Karp and head of its sustainability & ESG practice David Curran assessed ESG in general as a long-term trend, not a fad. The probability is high that ESG investing is, yes, sustainable.

However, standards have to be developed for methodological issues. The analogy is what is the usual in determining credit ratings. Right now in ESG investing, there is no such mandated process.

Not only is the credibility of fund managers at risk. There is also the value of the ESG investments to those who purchase them. In addition, Quinn indicates there is the possibility of lawsuits. However, as of this month none have been filed.

Research at MIT Sloan School of Management by Florian Berg has focused in much more detail on the overall consequences of the Tower of Babel. Recently Berg updated the study calling it “Aggregate Confusion: Divergence of ESG Ratings.” It is published in SSRN.

Essentially there are five major ones:

• There is no clarification of the ESG performance of entities ranging from a corporation to an investment portfolio. None of that can be discussed in a comparative way. The only possible analysis is within the unique system of that particular rater. Soon enough shareholders, particularly activist investors, could create an outcry about measurements which confirm nothing about how well or poorly a corporation is doing as regards Environmental Social and Governance issues.

• The ambiguity created by differing rating systems puts the kibosh on motivation to improve ESG. The commonsense thing to do would be to put a hold on any funding for ESG improvements until there is clarification. To the dismay of the front lines of ESG, businesses can get off the hook and justify that. Why plow resources in when the corporation really does not know where the vulnerable areas are?

• Such confusion puts a negative effect on the pricing of the ESG assets. In itself that could slow the growth of the sustainable investing niche. Also, it opens the door to lawsuits. Suppose the value of the asset has been depressed because there is no absolute data available and the rater's particular system has been challenged.

• Part of the raw deal is that there has been an extension into governance issues. The raw-deal part could happen to the C-Suite. That is because there are no absolute standards for assessing executive performance linked to ESG objectives. Yet, according to Corporate Secretary, 15 percent to 20 percent of businesses link leadership compensation to ESG criteria. It is not unthinkable that executives receiving lower than expected compensation would sue both their employers and the rating firm.

• Research will be slowed down. There is no common methodology and agreed-upon data to work with. Had that existed in psychology the discipline would never have been taken seriously.

Meanwhile, geopolitical and economic events such as the war in Europe and inflation are putting more pressure on business to showcase that they are doing the right thing. However, currently there is no universal agreement on the criteria for determining if the right thing is really part of the investment and how much of it is actually embedded in the asset.


Jane Genova applies journalistic strategies and tactics, including creative nonfiction, to brands and publications ([email protected]).