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by Matthew Welch,
Responsible Investment Specialist at DPAM
While the majority of investors agree on the benefits of sustainable investing, two famous voices in the US recently shared some opposing views. The first critique came from Mike Pence, the previous Vice President of the United States, and a known climate-change sceptic. His opposition to climate focused ESG regulation is in line with his previous standpoints, and not necessarily surprising. The second claim comes from Elon Musk, the tech billionaire and key player in the electric vehicle scene. While these only represent a small minority, their words can reach large audiences. So, it is important to have an objective look at both claims to clear up any confusion and debunk potential falsehoods.
Elon Musk argues that ESG has become overly politicised and an untrustworthy indicator of sustainability. The reason for this claim is that Exxon is rated top ten best in the world for ESG by the S&P500, while Tesla did not even make the list. At first glance, this seems surprising: An Oil & Gas company that is rated positively on ESG factors, while an electric car manufacturer does not even make the list.
During an energy policy speech in Houston, Mike Pence also stated that the interests of businesses and their employees are being rebuffed in favour of politicised goals, referring to a push by investor-activists to force companies to follow socially-conscious investing principles.
Both discourses demonstrate that a lack of fully understanding some of the fundamental principles of ESG.
First, it is important to clearly differentiate between ‘ESG’ and ‘Impact’. ESG scores by providers, such as S&P, try to enumerate the key environmental, social and governance risks associated to a company’s activities and its value chain. These risks can have a financial impact on the companies. Such ESG scores put a company in a broader context and should provide investors with a concise metric to consider the effects of a company’s activities on its stakeholders (i.e., employees, shareholders, and end-users). This means that ESG-rating companies tend to focus on company disclosure on ESG topics, such as the existence of health & safety policies, recycling programmes, renewable energy purchases, board diversity or significant controversies around ESG topics.
These ESG scores don’t necessarily put the emphasis on the impact of a firm’s final products and services, otherwise Exxon would probably not feature as highly in the rankings. This is also the distinct difference between ESG scores and Impact. The former looks at the ESG risks related to the generation of a product or service, and the latter looks at the product or service’s impact on stakeholders. Exxon, for example, might have implemented the most stringent health & safety policies, abide by solid ethics principles, and have an extensive environmental management system, granting them a high ESG score. Nevertheless, the company’s impact score is clearly far lower, as it produces around 3% of the world’s oil, which has a detrimental effect on most of its stakeholders. Tesla, on the other hand, is not scoring that well on ESG (based on the S&P methodology), due to its inadequate employee health & safety practices, allegations of discrimination, and the safety of its end-consumers1.
Backed by European regulation, asset managers need to make a distinction between having sustainable investments objectives (= Impact) and sustainable investment characteristics (= more ‘traditional’ ESG) in their product offering. Naturally, both principles are complementary. With the EU Taxonomy, the regulator tries to define and identify these impact activities and the SFDR regulation tries to prevent the conflation of ESG and impact, by clearly splitting objectives and characteristics.
All this to show that a truly sustainable and responsible asset manager needs to look both at the externalities of a company’s activity, bolstering the positive and diminishing the negative ones, and also encourage sustainable investments through investee companies’ products and services.
Global challenges and adequate solutions to these problems cannot always be represented by a ranking, a single score, or an index. The large discrepancy between ESG scores of different data providers reinforces this statement. Individuals that claim they are able to do so, prey on investor confusion.
We believe that our active, sustainable, and research-driven approach can properly navigate these challenges, clear the confusion, and identify the right opportunities for our clients.
1 Health & safety standards were deemed below par in Tesla’s Fremont plant and the safety of the company’s end-consumers did not score well due to allegedly mishandled investigations into injuries and deaths involving the car’s Autopilot feature.