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Future of ESG Ratings in Doubt as S&P Withdraws from Scores

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S&P Global has made the surprise decision to stop issuing alphanumeric ESG scores with its credit ratings, raising questions about the continuing use of such metrics by financial institutions.

The world’s leading provider of rankings on sovereign and corporate debt said it would cease providing scores on listed entities’ ESG performance with immediate effect. Instead, the company would continue providing only “dedicated analytical narrative paragraphs” that it believes are “are most effective at providing detail and transparency on ESG credit factors material to our rating analysis”.

The controversial decision comes as scrutiny of credit ratings has intensified amid growing criticism of their utility. With the number-one provider of such metrics exiting the market, experts speculate whether its largest competitors, Fitch Ratings and Moody’s Investor Service, will abandon their scores.

“Others may follow suit because the Big Three are an oligopoly, and S&P their market leader, so it is possible,” Daniel Cash, ratings and regulations lead at international law firm Ben McQuhae & Co told ESG Insight. “Also, there has been some investor criticism of the usefulness of the ESG scores in credit ratings, so it is possible the others will take the same course of action that S&P has.”

Can’t Compare

ESG scores have been criticised for a number of shortcomings. Most censure has focused on the variety of methodologies used by different ratings firms to arrive at their results. These have tended to generate inconsistent outputs that make it impossible for investors to compare the relative merits and risks of companies and their assets.

In response, regulators around the world are examining whether ESG ratings companies should be brought under their gaze. The European Union’s financial watchdogs earlier this year published a proposal to tightly monitor the companies, suggesting fines equal to 10 per cent of their annual revenue be levied for breaches of transparency rules.

In July, the UK’s Financial Conduct Authority published a proposed voluntary code of conduct that would commit compilers to adhere to six principles: good governance, securing quality, conflicts of interest, transparency, confidentiality and engagement. The code recommends a set of actions that raters should take and describes outcomes that should be targeted.

No Comment

S&P Global began publishing its ESG scores in 2021. It would give a 1-5 grade for each pillar of ESG – environment, social and governance. The scores were published alongside each entity’s credit ratings and were accompanied by explanatory paragraphs giving the reasoning behind S&P’s calculations.

The company gave no comment on why it had decided to stop the service now. Speculation, however, has been rife. Some media comments have focused on the anti-ESG backlash in the US, which has seen conservative-governed states seeking to legislate against public investments in sustainable and purpose-driven financial products.

Tesla chief executive Elon Musk fanned the flames of distrust among American conservatives last year when he criticised S&P for dropping the electric car maker from its flagship ESG index while notable energy and tobacco producers remained in it.

Bloomberg News cites sources saying that S&P’s decision was driven by feedback from investors confused by the scores.

Ben McQuhae’s Cash, dismissed suggestions that politics played a part in S&P’s decision as attempts to give a “culture-wars narrative”.

“The scores, if and when abandoned, never meant anything to anybody other than a rating agency attempt to show they were theoretically considering ESG, which is a misnomer,” he said. “They have always considered ESG and will factor it in when they deem it material, that’s it. Their actual methodological processes were not altered by the advent of applying ESG scores to a credit rating, and they will not be altered by removing them.”

Investor Disquiet

Nevertheless, it’s clear that many investors are dissatisfied with the inconsistencies in ESG ratings.

The latest annual edition of sustainability consultancy ERM’s Rate the Raters survey, published in the spring, found growing dissatisfaction with ESG ratings providers. The survey, conducted with the SustainAbility think tank, found that while ratings were still regarded as an essential part of investors’ due diligence processes, more than half of 1,800 professionals surveyed said consistency, comparability, quality and disclosure of methodologies were problems that needed urgent attention.

At A-Team’s ESG Data and Tech Summit London this year Chris Johnson, head of product management for market data services at HSBC Securities, said ESG ratings were the least understood of ESG metrics and added that he was frustrated that they were erroneously assumed to work in the same way as credit ratings. They are the “exact opposite”, he said.

Some investors have long complained that the metrics can’t be easily incorporated into their own data and analytics systems. Some, including Frankfurt-based CHOM CAPITAL, have begun compiling their own scores instead.

Square Peg

John Martin, chief executive and founder of Plutus Consulting Group, which offers ESG advice to financial institutions, said that condensing ESG performance into a simple score was problematic.

“Have you ever tried to fit a square into a circle without cutting corners?” Martin, a former M&A director at Barclays, wrote on his LinkedIn page. “If you end up cutting corners, logic will have it, it is no longer a square. ESG ratings based on subjective methodologies that are vaguely recognised without a framework or measuring ‘stick’, are a bit like the square.”

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