PLSA LA Conference: Concerns raised over 'fiendishly difficult' ESG data

Industry experts have emphasised the importance of remaining cognisant of the subjectivity of environmental, social and governance (ESG) ratings, also highlighting issues around the scope, consistency and reliability of the ESG data behind metrics.

Speaking at the Pensions and Lifetime Savings Association (PLSA) Local Authority Conference 2021, Dimensional senior portfolio manager and VP, Jim Whittington, highlighted a number of challenges faced when considering ESG ratings and metrics.

In particular, Whittington pointed to analysis from Refinitive, which has placed a coal company and tobacco company as two of the most sustainable companies in the FTSE 100.

Whittington acknowledged that this might "raise eyebrows" considering the poor sustainability profiles for these products, explaining however, that this is a result of the rating focusing on how companies manage risks, rather than the nature of those risks.

"This example illustrates an important point. An ESG rating only makes sense if you really understand what is being measured, and the scoring systems vary widely between different rating providers," he continued.

"They often don’t agree on which corporate behaviours count as sustainable, and what weight they should contribute to the overall score."

Indeed, commenting more broadly, Whittington emphasised that ESG is a subjective topic, and as such, any attempt to score ESG progress is also subjective.

"The aggregate score is highly dependent on which issues the rating providers think are most important," he added. "All of this means there is surprisingly low agreement between rating providers as to how they score individual companies."

In addition to this, Whittington stressed that the processes behind ESG ratings are "complex and opaque", explaining that it can be difficult to know what you are getting, with a "danger" that trustees may not get what they expect.

Indeed, Whittington pointed to a recent OECD paper as demonstration of this, as it found that there was no clear relationship between a companies environmental score and their greenhouse gas emissions, with some actually having a positive score.

"Generic ESG ratings are probably a poor place to start if your goal is to address specific sustainability goals such as managing climate risks," he suggested, noting recommendations that pension schemes look to source the raw data relevant to the issue instead.

"We recognise that there are many sustainability objectives, but we think that advice is good whatever your objectives are," he said.

However, he also stressed that the quality of any sustainability approach is "only as good as the data on which it is based", warning that ESG data has "significant limitations" and is "nowhere near as good as financial data".

In particular, he highlighted three key limitations of scope, consistency, and reliability.

"Even quantitative data can have reliability problems," he continued, arguing that ESG data can be "fiendishly difficult to calculate".

"For example," he stated, "Timberland, the shoe company, say that in order to accurately measure their scope three emissions, they have to capture the emissions profile for over 30,000 components that go into their shoes."

In light of these caveats on the limitations of ESG data, Whittington highlighted greenhouse gasses information, scope 1 and 2 emissions, fossil fuel reserves, and green revenues as higher quality data related to climate risks.

He clarified however, that these also carry challenges, explaining, for instance, that most companies have a mix of green, grey and brown activities, which can present problems when trying to identify green revenues.

"In addition, we also need to be cognisant that green revenues only account for a fraction of total company revenues, so there has to be a danger of too much capital chasing too few opportunities," he said.

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