This new American Council for Capital Formation report: "Ratings That Don't Rate" identifies numerous concerns (supported by a number of actual examples) about ESG ratings based on a study of the four purportedly dominant ratings agencies: MSCI, Sustainalytics, RepRisk, and ISS (E&S Score), including:
- Tendency for raters to equate more robust disclosure (in lieu of the effectiveness of the company's underlying ESG practices) with higher ratings
- Subjective and unchecked corporate reporting
- Rating agency biases toward larger companies (i.e., larger companies are given better ratings) and geographic areas requiring and fostering corporate disclosure/reporting, and consideration of industry rather than company-specific risks
- Inconsistencies among raters that result in dramatically different scores for the same companies
- Disconnect between ratings and manifested risks
These shortcomings notwithstanding, ratings are increasingly widely used among investors (which the author attributes largely to the 2005-launched UN PRI), with the number of funds incorporating ESG criteria reportedly increasing from 260 in 2007 to more than 1,000 in 2016, and MSCI boasting (pg. 3) that it provides ratings for 46 of the 50 largest global asset managers.
Notably, the report quotes BlackRock's determination (set forth in this September 2016 paper: "A Pitfall in Ethical Investing: ESG Disclosures Reveal Vulnerabilities, Not Virtues"), based on its study of ESG disclosure and the occurrence of regulatory actions and published ethical controversies, that - contrary to its expectations - favorable ESG practices don't correlate with better social performance:
Like most observers, we expected common ESG practices to be associated with better social performance (citing, for example, "Can ESG add Alpha?" MSCI ESG Research, June, 2015). We were wrong. Firms that disclose the widest range of socially responsible policies such as signing the UN Global Compact, disclosing "family friendly" employment policies, and monitoring suppliers' labour practices, are more likely to experience ethics controversies and adverse regulatory actions in the future.
The report includes an overview of each of the four agencies' rating scope, scale, and ESG focus.