Rating agencies using green criteria suffer from ‘inherent bias’


According to a report by the American Council for Capital Formation, agencies that judge companies on their environmental, social and governance metrics suffer from wildly divergent standards and “inherent biases.”

ESG is one of the biggest trends in the asset management industry, as demand for more socially responsible investment options has exploded in recent years. Approaches vary, but ESG funds tend to avoid companies in sectors like coal and private prisons, and favor companies that perform well on diverse boards and management.

The Global Sustainable Investment Alliance’s semi-annual survey estimates that the broader ESG universe grew to $23 billion in 2016, while JPMorgan estimates that around $2.5 billion of funds now use ” real” ESG measures.

“ESG investing is becoming mainstream as investors seek to minimize reputational and operational risk and seek ethical strategies without sacrificing potential returns,” JPMorgan analysts wrote in a recent report. “The active and systematic adoption of ESG factors in the investment process is in its infancy rather than at an advanced stage.”

This has spawned a number of agencies that rate companies based on their ESG metrics, much like how rating agencies rate companies on their creditworthiness as borrowers. Some of the biggest include MSCI, Indexing Group, Sustainalytics and RepRisk.

However, a report by Timothy Doyle at the ACCF, a pro-business think tank, claims that these ESG rating agencies are inconsistent and suffer from a range of biases, such as a tendency to award higher ESG ratings to larger companies or those based in countries with strict reporting standards, although this does not necessarily lead to higher quality disclosure.

“It is paramount that investors and fund managers have the information they need to make sound investment decisions,” the report says. “As investments in this area are based on a company’s ESG rating, the rating agencies that assign these ratings have a critical impact on investment strategies. Currently, there does not appear to be uniform criteria used by the three largest and most influential rating agencies.

MSCI and Sustainalytics did not respond to requests for comment, but Philipp Aeby, the chief executive of RepRisk, acknowledged that the rating discrepancies were “a huge problem”.

“The industry is still maturing and we expect convergence over time,” he said. “The fundamental problem is that it’s still unclear exactly what ESG should stand for.”

While S&P and Moody’s credit ratings for corporates and other borrowers are closely aligned – with a correlation of 0.9 – CSRHub, a data provider for the sustainability industry, calculates that correlations between MSCI and Sustainalytics for ESG ratings are well below 0.32.

For example, the ACCF document pointed out that Tesla has a lower ESG rating than all European automakers – several have been accused of colluding to evade environmental and safety regulations – largely because Europe has more onerous ESG reporting standards.

To illustrate the size bias, the report says Bristol-Myers Squibb, a $92 billion pharmaceutical company, has a Sustainalytics score 73 to 20 points above the healthcare industry average, while Phibro Animal Health, which manufactures animal feed, has a score of just 46.

The ACCF recommended that ESG disclosures in regulatory filings be standardized to help rating agencies make more consistent judgements, and that agencies be more transparent about their process and better adapt to size, sector and to legal jurisdiction.

More uniform reporting standards would make it easier for ESG assessors, but that requires industry-wide action, according to Aeby. “A quick fix would be to report simple metrics like board diversity or a company’s carbon intensity,” he said.


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