By Amelia Beale
Last month, S&P removed Tesla from its S&P 500 Environmental, Social and Governance (ESG) Index, surprising investors of the electric vehicle manufacturer. While the EV pioneer was knocked off the list, some questionable stocks remained, raising questions about the value of such indices.
In classic Elon Musk fashion, the Tesla CEO took to Twitter to criticise S&P over its decision, tweeting “ESG is a scam”. He points to the fact that oil major, Exxon Mobil, remains firmly on the Index, being rated in the top ten best in the world for ESG by S&P 500, whilst Tesla – a company who has actively provided an alternative to gas-guzzling cars – is not.
So, how has this happened?
Despite Tesla seemingly getting an easy tick for sustainability given its leadership in the EV industry, S&P claim that the company lacks a low carbon strategy. Tesla has also not performed well in its social and governance measures – from its poor response to federal investigations into casualties caused by its vehicles, to allegations of racial discrimination, to claims of poor working conditions at its Californian factory, the company has come up short in equally important social and governance measures. With Musk overlooking these key issues, S&P have claimed that Tesla has “fallen behind its peers when examined through a wider ESG lens”.
This is where the first issue arises. Companies on the S&P ESG Index are measured against industry group peers. So, while we see Exxon sitting comfortably on the list, it is because it’s being measured against other oil and gas corporations. The problem here is obvious – the rating does not represent industry-wide progress and reduces those with some of the biggest actions to make to a field of lesser competition.
Adding to this, the S&P ESG Index does not look at Scope 3 emissions, missing out a huge part of the picture. Disregarding these wider emissions has meant that Exxon has been let off relatively easy on the environmental front. Meanwhile, Tesla does not gain any credit for its hypothetically avoided emissions.
The variation between indices is also wide. As found by an MIT Sloan working paper, this confusion is rooted in three main sources: 53% due to measurement – measuring the same ESG attribute with different indicators, 44% due to scope – breadth of attributes, and finally, 3% is put down to the weight of individual components1.
A study by Research Affiliates represents this even more transparently. They found that when looking at two different research providers there were huge discrepancies between their view on a company’s progress2. In one example, Provider 1 ranked Wells Fargo as top quartile in Governance, while Provider 2 ranks it in the bottom 5%. This is because Provider 1 marks Wells Fargo’s fake bank accounts scandal within its “Social” score, rather than the “Governance” score.
… And so, perhaps Musk’s rant on Twitter is not to be dismissed.
With no clear set of objective markings, ESG progress can arguably be redefined in a moment’s decision, with “value” and progress figures rooted in subjectivity. The flaws within these industry benchmarks threatens the integrity of our reliance on them to provide a clear picture of companies’ progress and the definition of an “ESG” investment.
S&P’s decision comes at the same time as the announcement that the Securities and Exchange Commission will be cracking down on exaggerated ESG credentials in investment products. A crackdown that has come down even harder following the allegations of greenwashing from Deutsche Bank’s DWS – a case that once again highlights the continued failure of ESG standards.
Shareholders too are positively increasing their demands for more transparency. A few weeks ago, we saw the pressure rise from Exxon’s stakeholders as they called on the oil major to publish an audited report on how a net zero economy by 2050 would impact the “assumptions, costs, estimates, and valuations” underlying its financial statements. As trillions of dollars continue to flow into ESG funds, increased scrutiny and tightening disclosure regulation is an important step in tackling the lack of uniformity of these heavily relied on indices.
While it’s a positive to see Tesla held accountable for the failure to meet corporate social responsibility standards, it begs several questions: Can we truly quantify ESG objectively to create a standardised measurement? Perhaps, E, S and G are best separated? And, as we increasingly rely on such indices, how can we keep striving to make them better?
1 Berg, Florian and Kölbel, Julian and Rigobon, Roberto, Aggregate Confusion: The Divergence of ESG Ratings, 2019. Forthcoming Review of Finance, https://ssrn.com/abstract=3438533 or http://dx.doi.org/10.2139/ssrn.3438533