Last week, the CEO of Tesla, the richest man in the world and who may soon own Twitter against the ESG ratings, came out and called them a “scam.” In autonomous vehicle trials, and allegations of racial discrimination and poor working conditions at its California plant.
What is ESG anyway? Depends on who you ask. By and large, some argue that this is the most important business trend of recent years, and of the coming years. According to the concept, companies must take into account their activities in the aspects of the environment, society and corporate governance. Some would argue that this is the introduction of foreign values into the business world (such as sustainability and social justice), where the profit line is decisive.
Some argue that these are not values, or extra-financial metrics, but rather a comprehensive and integrated approach to the company’s essential ESG issues (and that can also affect its financial performance), and their management in the manner of managing the risks posed by them.
The rating agencies – entities whose names we are all familiar with (S&P, Bloomberg, FITCH and more) – try, as Oil suggests, to rank companies in these areas. Their importance to companies is great, because investors choose to invest according to a company’s rating in these indices, which will affect the flow of capital and investments to the company. With the entry of Generation Y, and even more so with the entry of Generation Z into the capital market and the labor market, this is a critical variable.
In practice, the form of work of the rating agencies is the sending of questionnaires to companies, on which they receive a score. Even without understanding anything in rating agencies, what ESG is and how to measure it – it’s easy to understand Musk’s frustration and the absurdity of oil giant ExxonMobil and McDonald’s being ranked above Tesla (a company that mainly deals with electric cars and accelerates the transition to low-emission transportation).
So what’s the reason for this?
Rating agencies measure ESG risk management – rather than impact on, and performance of, the criteria that make up the ESG. In more detail – the agencies examine companies’ coping with risk, and their willingness and seriousness to deal with the risk posed by the three criteria – social, environmental and corporate governance.
Elon Musk (Photo: REUTERS / James Glover II // File Photo)The test is sometimes really a binary test – whether the company has set and reported goals for reduction or carbon reset (Net-Zero), and not how much the company is polluting now. Tesla, in its recent sustainability report, echoed the claims of Musk and many others and accepted that the ratings “are based on how the company’s profits are affected by ESG-related factors, rather than estimating the company’s real impact on the company and the environment.”
Thus, even a polluting company like ExxonMobil can receive a high rating – if it is due to proper corporate governance, ambitious goals, building strategy and policy and appointing a function responsible for the climate issue. And if Tesla is facing the issues it mentioned at the outset that hurt its S rating, its “green” business model will not save it from getting a low overall score either.
In addition, it should be understood that each of the agencies has its own methodology for measurement, and the criteria it decides to generalize (some of which reach 700 criteria in their calculation). Each also has its own scoring method – a score of risk level (low, low-medium, medium and so on), a score between 1 and 100, an alphabetical score, etc. Most also do not publish the “behind the scenes” of the index – what criteria get what weight.
It turns out that when these rating agencies measure the financial strength and credit rating of a particular company, they will all give almost exactly the same score – with a compliance ratio of 0.99. In contrast, in the ESG rating the ratio stands at 0.66 – that is, a company measured in 3 of the ratings will receive the same score in only two of them.
It is important to remember that the main cause of confusion and inability to compare stems from the fact that there is not (yet) an agreed global standard for examining ESG. Add to this the fact that the measurement has to be adapted to different sectors, and that there are companies that are active in several sectors – both manufacturing, both technology and finance for example – so what will we measure them by? All of these add a dimension of complexity to a complicated and sensitive issue as well – and no wonder the world of ESG sustainability and investment is in the eye of the storm.
Adv. Yinon Barzani is a risk management consultant at EBA & Co, and runs the blog “Climate and Environmental Risks”