ESG metrics do not correlate to low carbon footprint – study

Corporations with high environment, social and governance (ESG) ratings cause just as much harm to the environment as their peers with low scores, according to research conducted by index provider Scientific Beta and published by the Financial Times on Monday. 

“ESG ratings have little to no relation to carbon intensity, even when considering only the environmental pillar of these ratings,” Scientific Beta research director Felix Goltz told the Times, adding that “the carbon intensity reduction of green portfolios can be effectively canceled out by adding ESG objectives.”

If anything, high ESG ratings were more likely to correlate to a larger carbon footprint, the researchers found, noting that when all three metrics were used, the resulting portfolios were less green than the average index weighted by market capitalization. 

Because social and governance metrics have nothing to do with a company’s carbon footprint or environmental policies – diversity initiatives and anti-corruption measures do not overlap with pollution controls or resource conservation – “it can very well be that a high-emitting firm is very good at governance or employee satisfaction,” thus netting a deceptively high ESG score, Goltz explained.

However, he acknowledged, “even the environmental pillar is pretty unrelated to carbon emissions.” Instead, he said, the metric was determined by more concrete attributes like water use and waste management. 

Ratings firm MSCI ESG Research, one of three agencies whose ESG ratings were used in Scientific Beta’s research, explained that ESG ratings weren’t actually meant to measure a company’s eco-friendliness, even if they had taken on that role in the minds of many in the media and business establishment. 

ESG ratings “are fundamentally designed to measure a company’s resilience to financially material environmental, societal and governance risks. They are not designed to measure a company’s impact on climate change,” the company told FT. Instead, the environmental pillar takes into account future plans to curb carbon emissions, clean technology investments, and management of nature-related risks.

The problem of ESG metrics operating at cross-purposes is likely to become worse before it gets better, according to Goltz, who pointed out that new metrics are constantly being added.

“Investors need to think carefully about which aspects of sustainability they would like to prioritize when building portfolios – carbon reduction or a high ESG rating,” Hortense Bioy, the global director of sustainability research at ratings agency Morningstar, told FT. 

Once hyped as the corporate solution to the planet’s problems by major industry figures like BlackRock CEO Larry Fink, ESG has fallen on hard times in the last year. Fink revealed in January that the asset management behemoth had lost $4 billion in assets under management due to the anti-ESG backlash and in June admitted he had stopped using the “weaponized” term. 

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