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15 Dec 2021 | Third-party ratings face fury; Shell hits 0.05% of tree target; time to retire 'ESG'?

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💰 “No company is more critical to Wall Street’s new profit engine than MSCI, which dominates a foundational piece of the business: producing ESG ratings.” And so the tide turns, as Bloomberg reveals the extent to which MSCI is capitalising on a lucrative gap between perception and action.

👩🏻‍⚖️ Regulators are set to weigh in. EFAMA has called for regulation of ESG data and ratings, soon after IOSCO made recommendations to regulators to do the same. Even without external pressure, third-party providers will need to think about how they fit into a world of regulated corporate disclosures.

🤑 The UK has COP contagion. Calastone found UK ESG equity funds attracted a record £1.5B ($2T) in November, as climate talks spurred investment action. According to Morningstar data, sustainable assets hit £172B—12.2% of the total UK-domiciled open-end universe—in the run-up to COP26.

📈 On the global stage, a report from Broadridge predicts assets in dedicated ESG mutual and private funds, ETFs and institutional mandates will grow from $8T today to $30T by 2030. Expect more “thematic strategies, climate transition and net-zero solutions, and investments offering measurable impacts.”

💥 As it explodes, is it time to retire the term ‘ESG’? With the number of uncorrelated factors and strategies for which it accounts growing, it’s getting hard to define and even harder to deliver in a fund. Bloomberg says the scope and subjectivity make direct indexing a likely next step for investors.

Chart of the week: An ESG index monopoly multiplier

Last week, Bloomberg published a blistering attack on MSCI for its perceived role in popularising (and profiting from) the idea that ESG has any impact on the planet and its people. Which, as you, and I, and hopefully everyone in this industry knows, is not the point of ESG.

ESG originated as a lens through which to better understand how world events might risk a company's enterprise value, not how a company might risk the world. To be fair, the ratings agencies don’t claim otherwise. Clients, too, know exactly what they’re buying, as should sophisticated (mostly institutional) investors.

Unfortunately, the average end investor, guided by exuberant asset management marketing teams, does not. It’s amazing what a photo of a forest (extra points if juxtaposed with a lake) and some creative combination of the words ‘green’, ‘sustainable’, ‘better world’, ‘climate’, and, of course, ‘social’ and ‘environmental’ can do, particularly in the absence of meaningful information about underlying holdings and their genuine social and environmental impact.

The chasm between perception and reality, marketing and methodology, is something out of which asset managers and ratings providers have made an enormous amount of money. Particularly MSCI.

And that really is an issue, because it doesn’t just deliver data; it also builds and weights indexes. A lot of them. Bloomberg finds 60% of all retail money plowed into sustainable or ESG funds globally has gone into those built on MSCI’s ratings.

So: The myth (that ESG investing creates positive impact) attracts money (earmarked for ‘good’), which MSCI allocates to companies (who, like McDonalds, may be very good at installing recycling bins to appease regulators but very bad at bringing its emissions down to the level of, like, one, rather than two, countries).

Now think about that at scale. If the two biggest financial trends of our time are passives and ESG, and MSCI has a monopoly on both, any failings in the latter are amplified by the former.

Take the mammoth iShares MSCI ESG Aware USA ETF (ESGU) (chart below, left), which tracks the MSCI USA Extended ESG Focus Index and aims to capture “US companies that have positive environmental, social and governance characteristics as identified by the index provider.” It’s exposed to McDonalds (the company on which Bloomberg focuses) because, according to the analytics department of said index provider, McDonalds has a respectable BBB rating.

A story of two ETFs, the left of which tracks the MSCI USA Extended ESG Focus Index, and the right, its parent index MSCI USA Index. Showing negative and positive revenue alignment versus the 17 Sustainable Development Goals.

Extraordinarily successful, ESGU has grown from $14 billion to $25 billion in six months, taking investment into McDonalds from $52 million to $91 million. A-rated JP Morgan, the world's leading fossil-fuel financier, now gets $324 million from the ETF.

ESGU is just one of many ETFs tracking that particular index, itself just one of many MSCI ESG indexes that form the basis for many other well-marketed ETFs, and McDonalds just one of very many negative-impact companies receiving billions from investors who buy the line they’re “making better decisions for a better world.”

If questioned, distributers can defer responsibility to MSCI's methodology. As will any manager seeking to add credibility to the sustainability funds it builds and sells.

So, the end investors defer to the ETF managers defer to the index providers defer to the companies to provide rigorous extra-financial information to inform their grade.

But how rigorous?

Story of the week: Nature BS

As the saying goes, blessed is he who plants trees under whose shade he will never sit.

Shell is very blessed indeed. To support its journey towards net zero by 2050 (with a target to reduce emissions 50% by 2030), the major is embarking on the most ambitious horticultural project since Eden.

On its website, Shell says: “We set a target to reduce emissions 50% by 2030.”

Fine print: Target “allows for nature-based solutions (NBS).”

Finer print: “Shell’s operating plans, outlooks, budgets and pricing assumptions do not reflect our net zero emissions target.”

If its assumption—that oil prices will remain stable—isn’t changing, Shell doesn’t see the industry or society shifting to renewables. Presumably because operating plans aren’t as ambitious as marketing campaigns would have you believe.

OK, fine, but maybe the NBS strategy is really good? After all, in its response to the CDP Climate Change request for information, Shell outlines a plan to offset 120 million tonnes of CO2 by “planting forests.” According to ActionAid, that amounts to about 12 million hectares of land by 2030.

Back to Shell’s website. On its dedicated NBS page, it speaks to three projects: five million trees in the Netherlands, 300,000 trees in Spain, and one million trees in Scotland. A total 6,300,000 trees. Assuming 1,000-2,500 trees per hectare, that’s 2,520-6,300 hectares. Of 12 million. 0.05% of its disclosed target.

Coming up slightly short, but A for effort. Or AA, if you ask MSCI.