ESG investing needs rigorous evaluation to avoid credibility risk
THE scandal that has blighted French nursing home operator Orpea SA, a stock picked by funds focusing on environmental, social and governance (ESG) goals, is a rude reminder that ESG investing needs more rigorous evaluation to ensure corporations walk the talk, and not simply tick the boxes.
Orpea was among the best rated in the sector in terms of ESG criteria. Sustainalytics, one of the leading rating companies in Europe, gave it a score of 2 on a scale of 1-5, with 5 being the worst. When allegations of patient abuse and financial malpractice came to light, investors were caught off guard. Orpea's shares took a heavy beating, plunging a whopping 60 per cent year-to-date even as its chief executive officer was terminated and 2 firms hired to investigate the allegations. More than a corporate public relations nightmare, the Orpea scandal has highlighted the inadequacy of the ESG framework. Analysts at Scientific Beta, a research venture of the Singapore Exchange, and EDHEC Risk Institute said the "unreliable nature of these inputs not only limits their usefulness but can at worst have negative impacts on the achievement of real-world ESG goals sought by investors".
ESG investing has gained traction in recent years, rising to more than US$35 trillion in 2020 to account for more than a third of total global assets under management, according to the Global Sustainable Investment Alliance. This figure is expected to rise beyond US$50 trillion by 2025 as more funds seek to effect positive change. Despite this rapid growth, there remains deep skepticism, not least ambiguity over which investments can be labelled ESG-compliant and how an investor can ascertain and verify claims. In Europe, the implementation of the Sustainable Finance Disclosure Regulation last March led to funds dropping more than US$2 trillion in assets from ESG labels. While the Chartered Financial Analyst Institute published new guidelines on ESG product-level disclosures in the United States last November, there remains no single, centralised way to measure ESG performance.
It remains very difficult to objectively measure ESG metrics, especially the social aspect which includes human rights and labour practices along a supply chain. This is why many companies including Tesla, with questionable social performance, are included in ESG funds. While electric vehicles are critical to combat climate change, the batteries like Tesla's require cobalt, a mineral found in the Democratic Republic of Congo, where serious human rights violations including widespread exploitation of child labour and safety hazards in deep, unstable mine tunnels, have been reported.
If ESG investing is to fulfil its promise of encouraging better corporate behaviour, it needs to be grounded on more accurate and universal assessments of corporate practices. The onus still falls on investors and their advisers to remain vigilant and scrutinise the data presented to ensure that ESG champions are delivering what they promised.
