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ComplianceAugust 03, 2022

What is more important: Materiality or ESG scores?

ESG has dominated investment newsfeeds this summer. What to do with ESG scores is THE question for corporations and investors alike. A panel at GreenFin 22, held in New York at the end of June, examined this question.

Panelist William Atcheson of Jefferies feels that the scores don’t have much value yet because of their lack of consistency and transparency.

But the push for ESG scores has done something right.

The movement has created data banks and identified key performance indicators (KPIs) that are material, says Atcheson.

“For us at Jefferies,” he says, “ESG investing should be a good analysis — leveraging a materiality map that identifies intangibles and externalities that account for about 90% of the market cap value and using this lens to identify better risks and opportunities associated with it. This is where the value of ESG is today.”

Standardization or diversity?

Rich Mattison, S&P Global Sustainable1 President, says “we need better transparency, better clarity, better disclosure” to make ESG scores worthwhile. And there are a number of efforts throughout the world working to rectify exactly these things.

At the moment, ESG ratings are being used as one would use a company’s credit score when determining ‘investability’.

Maybe this is the wrong approach.

Mattison suggests that instead of comparing ESG to credit ratings, where there is a singular score, investors should use earnings estimates. In this scenario, diversity of opinion is valued because all aspects of a business are analyzed.

However, this is a very complicated process.

Mattison asks: “Should we be aiming for a more precise, singular, defining value of ESG or should we be thinking of valuing the diversity and understanding why there is such a difference of opinion? This is an open question.”

Andrew Siwo, Director of Sustainable Investments and Climate Solutions for the New York State Common Retirement Fund, suggests that instead of looking at standardization, comparability might be a better target. “We need to compare car companies to car companies and oil companies to oil companies,” he says. This is the only way for numbers to make sense.

Siwo argues that transparency is already there, but it is hard to compare a consumer products company to an entertainment company to an oil company under the auspices of ESG standards.

“When we start to make ordinal comparisons, the second-place person never gets the prize,” he says. This isn’t fair unless one is comparing apples to apples.

If not an ESG score, then what?

Atcheson was very upfront about what his company if looking for. And it wasn’t a singular ESG rating.

“Dynamic materiality — we are a big proponent of the materiality map approach,” he says. “We want to identify a few material things that really drive a company’s performance.”

As far as metrics, Jefferies is incrementally focused on human capital. “No one is really looking at this yet and it is easy to measure,” Atcheson says. Also, every CEO says that their biggest asset is their employees.

Jefferies focuses on three primary human capital metrics:

  1. An internal Net Promoter Score (NPS)
  2. Employee engagement
  3. Employee turnover

“We are still trying to figure out the environmental aspect,” he adds. There are valuable insights from ESG. But he thinks that there is more value in the SASB MSCI linkages.

“I would ask raters to do this one thing,” he says, “build more data sets and then run correlations with them against line items in individual companies.”

The bigger picture

Mattison says that financial relevance is critical. However, if just focused on this, one misses the bigger picture.

“We are trying to create an impact in the world,” he says, “financial risk is important but we need to balance this.” Companies can’t just focus on the bottom line if the environment is to be protected. For this, both risk and impact are important factors for a true ESG rating.

In addition, this information should show future disruption as well as future activities. “It isn’t just about the earnings of one company,” says Mattison. One needs to ask where in the world are we going to see geopolitical shifts in water scarcity, for example. This is important for boards, investors, analysts, and others, to consider.

Finally, GreenFin 22 speaker Erika Karp, Executive Managing Director and Chief Impact Officer at Pathstone, proposed that there really is no such thing as ESG investing. There is only ESG analysis, “ESG investing is a discipline and not a product.”

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