Overview
The recent introduction of ESG scores have finally allowed us to quantify the environmental sustainabilities of different companies. ESG (Environmental, Social, and Governance) Scores appear in a few different ways. There are general ESG scores, which are overall ratings of companies and their sustainability (environmental), their employee and community relations (social), and their commitment to anti-corruption practices as well as their effectiveness when it comes to how their executive board makes decisions (governance). You might be wondering why an environmental policy blog is so concerned with such a thing, to which I answer that ESG scores serve as the perfect intersection between finance and environmental policy because through using these scores, companies will be pushed to become more environmentally conscious, as these scores give more attention to that previously overlooked aspect of investing. Through using a objective ESG framework to compare companies to each other (as well as the industry standard, whatever that may be for that particular industry), investors can now more effectively engage in risk management for their investments in companies (as violation of environmental or social standards by a company will surely lead to a poorer return on investment), as well as long term value creation. Looking at ESG scores from a purely positive perspective, it is easy to see how they are contributing to a greener future. For example, the use of a standardized ESG framework is very effective at preventing greenwashing, as third parties that create these scores (such as NGOs like the Carbon Disclosure Project and companies like Bloomberg, MSCI, and FTSE Russel) can create specific objectives that companies need to meet in order to be given a high ESG score (what that is varies for each company, as a score of 0 would be bad for Bloomberg, but that is the highest score for the system used by the company sustainalytics).
Why are ESG scores controversial?
The issue that many policymakers in the US take with the mandating of ESG score releases is the lack of regulation and standardization when it comes to how ESG scores are produced. One case that encapsulates this lack of standardization would be Tesla’s recent removal from the S&P 500 index due to concerns about the company’s sustainability (which came about due to a low ESG score), even though McDonalds (which output more greenhouse gas emissions than Portugal or Hungary in 2019) is still on the index. This lack of standardization is why there is a lot of criticism of ESG scoring, as the non-objective nature of it makes them seem kind of disingenuous. This is why congress voted to not pass an ESG bill that would allow retirement plans to consider a company’s ESG scores when investing. Many congresspeople view the implementation of ESG scores as a way to force companies to follow a “woke” agenda. One thing that European nations have done to effectively implement the consideration of ESG scores is standardizing the way that companies need to disclose climate related risks that come with their operations. This standardization helps to prevent greenwashing, and thus invalidates the “wokeness” point that many American policymakers make against the implementation of ESG scores. However, another criticism that people have made against the consideration of ESG scores by retirement funds is that once ESG scores are implemented, there are many profitable companies that retirement funds probably will not be able to invest in anymore. For example, let’s say that someone wishes to buy a lot of shares of ExxonMobil for their retirement fund. Assuming that ExxonMobil does not make any massive effort to move away from fossil fuels in the near future, it is reasonable to assume that their ESG score will fall short of whatever standard investors have, and thus will turn away those running the retirement fund. This is where the argument that the implementation of ESG scores removes a certain level of personal choice when it comes to investment comes in. So other than moving towards more standardization, the question of weighing environmental protection over economic gain comes into play. As a whole, the motives behind ESG score consideration are admirable, but the implementation needs a little tweaking.
Sources:
https://money.usnews.com/investing/news/articles/what-is-an-esg-score
https://fortune.com/2023/03/01/congress-war-against-woke-esg-investing-what-is-esg/#
https://www.armanino.com/articles/esg-scores/
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