Week 3: ESG ratings are just opinions

In this issue: ▸ Covid has increased inequality ▸ Purpose driven business as usual ▸ ESG ratings are opinions, nothing else. Full stop. ▸ Taxonomy broken dreams ▸ “Thank God for the oil producers”

Dear all, 

Building back what? 

Am I awake? The feeling of a truck parked on my forehead has been there for some days now. That unreal feeling of reality. Absolute vs relative.

Is my life worth defined in absolute or relative terms? Is the value of my being determined by mathematical theories of a market economy where everything has its place, meaning and can be explained? Absolute vs relative.

That thought keeps hitting my head the entire morning. Is that me reading about stuff that I do while I sit still in my chair at my desk quietly looking at the screen? Or is it really me?

I’m trying to agree with myself that insomnia might be to blame. I’m reading pieces of text in front of me and pinching myself. Standing up, sitting down, looking through the window. It is cold outside. From time to time a car passes by. People are walking outside. It is quiet. No riots, no demonstrations.

I turn on the TV, just regular stuff, people sitting in sofas in studios, smiling, nodding. Weather, sports, news sections. All the same. Russia may or may not attack, inflation is coming, Djokovic is expelled from Down Under, China will push through with the Olympics. Quiet hysteria. Is this for real?

A pair of dark black eyes staring at me. I look at them. I try to say something but my voice is weak. My mind dwells into a space with that half-awake, half-real nightmarish feeling.

Later in the day, I read what I will share with you now. It’s real and unreal at the same time. We accept it, like we accept that Earth spins around. Or maybe it really is flat? 

Covid has increased inequality

The coronavirus pandemic has worsened the massive financial gap between rich and poor around the world, a new report has found. Global billionaires last year enjoyed the steepest increase in their share of wealth since the World Inequality Lab began keeping records in 1995, according to the analysis released Tuesday.

The billionaires’ net worth grew by more than $3.6 trillion in 2020 alone, boosting their share of global household wealth to 3.5%. At the same time, the pandemic pushed about 100 million people into extreme poverty, raising the global total to 711 million in 2021, according to a World Bank estimate cited by the analysis.

Even more people would have fallen into poverty had many developed nations not enacted relief efforts to shield their residents from the financial fallout from the Covid-19 pandemic.

The Covid crisis has exacerbated inequalities between the very wealthy and the rest of the population.

The World Inequality Report is based on more than four years of work by more than 100 researchers around the globe. Longtime inequality experts Emmanuel Saez and Gabriel Zucman, both at the University of California, Berkeley, and Thomas Piketty of the Paris School of Economics, coordinated the report with Chancel.

Financial deregulation, privatization and less progressive taxation in richer countries and large-scale privatization in emerging economies has helped boost the fortunes of the wealthy in recent decades, the report said. 

“Global inequality is close to where it was at the peak of Western imperialism in the early 20th century.” 

I’m reading that sentence again. Real unreal, thus real. How could we? We know what happened last time, right? Unreal.

Billionaires have had a terrific pandemic. Central banks pumped trillions of dollars into financial markets to save the economy, yet much of that has ended up in the pockets of billionaires riding a stock market boom.

Inequality at such pace and scale is happening by choice, not chance.

The World Bank estimates that 97 million people worldwide fell into extreme poverty in 2020 and are now living on less than $2 a day. The number of the world’s poorest also rose for the first time in over 20 years.

Vaccine inequality has become a major issue as many of the world’s richest countries hoard shots, buying up enough doses to vaccinate their populations several times over and failing to deliver on their promises to share them with the developing world.

This is us, this is who we are. Real? Yes, very real and still the quite tranquil feeling of unreal.

Now, I did some research to find a piece of ESG white paper, or a statement, or a policy or whatever on this topic of rising inequality during Covid. I found nothing.

It is unreal that the ESG “world” has failed so copiously on this. 

Purpose driven business as usual… 🤦🏻‍♂️

Big words have short legs most of the time. Because when they fall, and usually they do, they want to land without pain.

Corporate purpose has gone mainstream. Is it a transformation? A new world of enlightened capitalism? Not a bit of it.

Even though corporate purpose statements are appearing everywhere, for most companies, it’s business as usual with some pretty tinsels on the side.

In an extensive piece of research including interviews with 49 asset managers with a total of more than $19 trillion under management, 26 asset owners, and 33 companies with average revenues of $45 billion in 15 countries, a study from Oxford’s Said Business School has uncovered why anyone who sees a purpose revolution in progress needs to get their eyes tested. They need a reality check, which is exactly what this article by the authors of the study seeks to provide.

The study addresses the investment chain and the purpose and governance of financial institutions themselves. These should be addressed before corporate purpose can be truly authentic. 

The simple and consistent message that institutional investors conveyed is that they don’t see purpose being practiced in the companies they invest in. Investors think companies are not taking it seriously and their communications about it are shallow and flimsy, lacking substance and any mechanisms for accountability.

There is a significant difference between Europe and North America in this regard, with the cynicism about U.S. companies being particularly pronounced.

There was a widespread appreciation amongst investors of the significance and potential of corporate purpose. In theory, it was seen to be important to discussions about the role of business in society, helps to attract and retain employees, improves relationships between suppliers and customers, enhances business resilience, and promotes a long-term perspective on a company.

It also provides a holistic view on a company, aligns practice and strategy with intent and vision, and makes businesses relevant in a rapidly changing world.

ESG ratings are opinions, nothing else. Full stop.

Perhaps the best way to think of ESG ratings is like the buy/sell/hold recommendations of Wall Street analysts: These are opinions.

They will sometimes be right and sometimes wrong, and you might choose to pay attention to someone whose approach you respect. But as with an analyst recommendation, most of the value comes from the underlying discussion, not the ratings themselves. 

For example, Credit Suisse may have received a failing grade on the governance aspect of ESG, but only if an investor looked at the right ratings agency, with the Swiss bank taking on an excellent, terrible, or neutral score depending on which agency is making the ratings.

Credit Suisse just lost its chairman, António Horta-Osório, who quit after breaching Covid-19 quarantine rules. The current chief executive was hired after the last was fired in response to revelations that a former employee was being spied upon.

Furthermore, the executives had been rebuilding Credit Suisse after its board reported careless risk controls and heavy lending losses on failed hedge fund Archegos Capital Management and Greensill Capital.

Even with these governance problems, the various ratings agencies can’t agree on a single ratings score for Credit Suisse.

Among the various rating agencies, S&P Global was the most negative on Credit Suisse’s governance, giving the bank a 15% score for corporate governance, or 725th out of the 747 banks and diversified financial groups globally rated.

On the other hand, Refinitiv was the least critical of Credit Suisse, giving the bank a score of 95% on its “management” category and 81% for governance as a whole.

With a more lukewarm analysis, MSCI ranked Credit Suisse as having average governance.

This is symptomatic of one of the great difficulties for those who promote the shallow type of ESG.

If the experts have wildly differing opinions on a basic matter such as good governance, how can we expect agreement on more controversial topics such as the environment, employee relations or social impact? 

Taxonomy broken dreams 

How are we going to explain to our clients that our products, which might score lower on taxonomy-alignment, are more sustainable than other products?

Now, that is the question that the EU taxonomy has made so complex to answer that birds on the trees across Europe sing in the middle of the winter.

Much of the tension boils down to the taxonomy’s dual purpose: avoiding misrepresentation by investors but also determining future EU funding decisions.

Giving a temporary green label to gas projects could facilitate cleaning up coal in countries like Poland, while the inclusion of nuclear would direct private finance to France or the Czech Republic.

To prevent the inclusion of gas and nuclear would require at least 20 member states – representing at least 65% of the EU’s population – to collectively reject the rule in the coming months, which seems unlikely. France’s power supply is dominated by nuclear, while countries from Germany to Poland still generate much of their electricity from coal.

Yet the EU’s current proposals may not even be legal, as they aren’t consistent with the target of limiting a global rise in temperatures, according to the two lawmakers responsible for guiding the legislation through the European Parliament. A body created to help the EU reach net-zero carbon emissions by mid-century intends to slam the move.

Other investors warn that the EU’s plans could have knock-on repercussions for future pieces of climate legislation such as the EU Green Bond Standard that aims to raise the bar for checks and balances in the $3 trillion sustainable debt market, where any issuance so far by fossil-fuel firms or nuclear generators has been controversial.

The move to include them in the taxonomy could end up creating a two-tier system of sustainable assets as investors superimpose their own environmental scruples onto the EU’s definitions.

Asset managers need to explain clearly what they are doing – with and without gas and nuclear – and that my friends will be awfully complicated. 

“Thank God for the oil producers”

Why will it be complicated? Well, real is unreal and vice versa.

Wall Street’s biggest investors are welcoming back oil and gas stocks, and not just because of their knock-out performance over the past 18 months.

Forward-looking fossil fuel producers will play a “critical” role in decarbonizing the world economy, BlackRock CEO Larry Fink said in his annual letter to CEOs on Monday.

Meanwhile Ray Dalio, founder of hedge fund Bridgewater Associates, praised fossil fuel producers in their role in tamping down inflation.

Seven of the top 10 performers in the S&P 500 are oil stocks, which added to outsized gains last year. Most U.S. oil companies have transformed their business model since the pandemic to focus on generating free cash flow rather than expensively growing production at a cost to shareholders and the environment.

Fink emphasized that divesting from fossil fuels, as many endowment funds such as Harvard done, won’t drive the world toward low carbon.

Dalio, whose Bridgewater manages about $150 billion, went a step further, saying oil companies are playing a critical role in stemming inflation. 

“Thank God for the oil producers” for providing reliable supply, Dalio said Monday on a panel at the Abu Dhabi Sustainability Week summit…

That truck being parked on my forehead feels more and more unreal. After all, what is real? 

Kind regards,
Sasja