What Are ESG Scores? – Opinion

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The rise of socially-conscious investing is one reason sustainable investing is a hot new trend in financial services. These sustainability goals are institutionalized in our economic system through the use of ESG scores (environmental, social and governance).

Their utilization has exponentially increased in recent years, with 98 percent of U.S. companies now disclosing ESG scores, and more than 15,000 companies worldwide signing on the United Nations Global Compact – an initiative to use ESG for tracking the UN’s Sustainable Development Goals (SDG). This system was first sponsored by the United Nations and other international organisations like the World Economic Forum or mega-financiers such as Larry Fink.

You aren’t the only one who is confused about what ESG scores really mean. This system is confusing. Yet, the implications associated with this system’s implementation are important to understand.

ESG Scores are basically a social credit framework that allows for sustainable reporting. They are supposed to measure both financial and non-financial aspects of a company’s overall risk profile. Companies with favorable credit ratings are therefore attractive targets for investment, whereas companies with unfavorable credit ratings are “screened out.” Ultimately, their utilization alters how businesses are evaluated, grading them on the basis of their commitment to social justice and environmental causes rather than traditional financial metrics.

Although it may seem that companies have a standard by which they can objectively be evaluated, this is not the case. Multiple systems are used, each sponsored by different governments and international financial institutions. Additionally, there are numerous ratings agencies such as Moody’s and S&P, each of which applies its own unique methodology to assigning scores. Studies have even shown that a rating agency’s subjective view of the firm under observation has influenced their rating to a significant degree.

Data itself is another area that could cause confusion. Let me give you an example from the International Business Council’s (IBC) system. This ESG system incorporates 55 metrics, which range from quantitatively determined “Total R&D Expenses” and “Total Social Investment” to qualitatively determined “Purpose-Led Management.”

The metrics are subjectively weighted according the corporate stakeholder preferences, then compiled into one score. It is difficult to countenance a scenario in which that score is an accurate representation of a company’s risk profile.

These stakeholders have the power to determine these metrics. This leads us into the worst aspect of ESG: Financial elites such as banks, corporations and ratings agencies are completely in control and can alter their metrics at will. As metrics are not determined by a government agency, instead being a product of the “free market,” no oversight mechanism exists to constrain their influence.

One, it has enabled those who capitalize on and drive ESG scores, to be extremely rich, sometimes at the expense or disadvantage of others.

Investments in sustainable funds reached $50 billion by 2020. This is 10 times more than the 2018 figure. ESG’s novelty has enabled financial institutions to charge higher portfolio management fees and reap the benefits. This system allows investment banks and financial firms to generate large capital flows to any location they wish, enriching their clients and friends.

Moreover, the ESG system has been used to consolidate wealth amongst the individuals responsible for the movement’s genesis. Blackrock – the world’s largest private asset manager – recently hit $10 trillion in assets under management, powered in large part by ETFs. The iShares Global Clean Energy ETF, one of its largest ESG funds, is among the best in the world.

Blackrock’s CEO? Larry Fink. Larry Fink is the same Larry Fink, who along with Charles Schwab could be considered the founders of the whole ESG system and the move to an overall model for stakeholder governance.

The worrying precedent is being established, however, beyond the wealth consolidation issue. Blackrock is one of the most powerful Wall Street investors. They have increasingly been able, through their power over ratings and the voting blocs that they control in corporate boardrooms, to dictate small business and company affairs.

The society is also at their disposal. ESG’s creators have the power to coerce social media companies into banning content. It could also be used by the system to change consumer behavior. For example, it might encourage people to drive electric cars when they would prefer to own a petrol-powered car. ESG frameworks could be used as a way to require certain choices in food and drink, while promoting sustainable options.

Take a look at the following:

If your local government requires a large outside investment in order to finance something such as a school building or road repair, what options are available? The investors they might approach could very well coerce that government into adopting certain community-level standards in exchange for the loan, because the municipality is not considered “green enough.” In this hypothetical – yet not so far-fetched – scenario, the city’s inhabitants would be forced to abide by the municipality’s new laws and regulations, leading to severe restrictions upon their individual freedoms.

ESG systems can be modified at any moment. However, only a few elites have the power to do so. It is designed so. Public opinion is not available. Although these people have been elected to office by the public, they are still at our mercy.

Do you find that this sounds like democracy?

Jack McPherrin ([email protected]) The Heartland Institute is her research editor.