May 25

Analysis: It’s Time to Give Companies Standalone Climate Ratings

By Felix Mormann, Milica Mormann

Environmental, Social, and Governance (ESG) ratings have clearly caught the market’s attention. In 2021, over $120 billion poured into sustainable investments, more than double the $51 billion logged for 2020. When it comes to climate change, however, ESG ratings are an imperfect vehicle to convey investor-relevant information. Instead, we need to assign companies a stand-alone rating focused on climate risk. Such a climate-specific rating can distill complex information regarding a company’s carbon footprint and climate risk into an intuitive, user-friendly format, while avoiding the flaws that currently mar ESG ratings.

One prominent flaw of ESG ratings lies in the definitional and methodological variations across rating agencies. Consider the example of Tesla Motors, the world’s leading manufacturer of electric vehicles. With transport electrification widely hailed as a cornerstone of global strategies to alleviate air pollution, reduce greenhouse gas emissions and mitigate climate change, one might expect Tesla to ace at least the environmental component of ESG ratings. Sure enough, MSCI’s ESG index has previously rated Tesla at the top of the auto industry. At the same time, however, FTSE rated Tesla’s environmental performance at “zero,” ranking the carmaker behind oil-and-gas major ExxonMobil in terms of sustainability. These and other inconsistencies across ESG ratings not only confuse investors searching for guidance but, more generally, threaten to erode popular faith in the ESG concept itself. (Tesla CEO Elon Musk made a similar argument last week.)

Photo courtesy of Diverse Stock Photos.

Source: Harvard Business Review (link opens in a new window)

Energy, Impact Assessment
climate change, electric vehicles, ESG