By guest author Jasmin Malik Chua from Vogue Business
The spectacular growth in interest from investors in environmental, social and corporate governance (ESG) shows no signs of slowing down. But making sense of all the benchmarks is a tough call.
When Michael Beutler joined Kering’s sustainability operations team as its director in 2011, the fashion conglomerate, then known as PPR, fielded at most four investor requests a year about its environmental practices.
Nearly a decade later, the Gucci and Saint Laurent owner receives at least four of these questionnaires a month. “If not double that,” Beutler says. “They take a long time to respond to — and they evolve and change each year.”
Environmental, social and corporate governance, or ESG for short, has exploded from a niche concern to table stakes. Between 2011 and 2019, the proportion of S&P 500 firms reporting on their ESG performance surged from less than 20 percent to 90 percent, with the contents of those reports “dramatically expanding over time”, according to the Governance & Accountability Institute, a New York consultancy.
The shift is indicative of the growing view that companies must meet consumer demand for sustainability or else sacrifice profitability. For fashion, an industry near-synonymous with profligacy, pollution, labour abuses and climate impact, the pressure for brands to pivot to better-for-the-planet practices — and one-up their competition — has never been more acute.
To fill this need, hundreds of rating and ranking companies, including the Dow Jones Sustainability Indices (DJSI), EcoVadis, Sustainalytics and MSCI, have sprung up to help asset managers, institutional investors, would-be employees, consumers and other stakeholders assess, measure and benchmark a company’s ESG performance. But while the ratings are designed to distill various sustainability achievements — or lack thereof — into easy-to-understand scores that elevate one company’s efforts above another, critics say they can further muddle our understanding of corporate social responsibility and even impede meaningful progress.
A single brand may engage in multiple benchmarks — or none at all. Prada, for example, doesn’t take part in any ratings. (It declined to say why.) Burberry, on the other hand, is not only listed in the DJSI, where it ranked third in the textiles, apparel and luxury goods category in 2019, but also participates in rankings by the Carbon Disclosure Project, the Workforce Disclosure Initiative, FTSE4Good and Sustainalytics.
Traditional investment data providers, credit rating agencies and more are vying for a slice of the ratings pie through mergers and acquisitions, such as Moody’s majority stake purchase of Vigeo Eiris in 2019. All this has only increased the complexity of the ESG ecosystem, writes Christina Wong, principal consultant at London’s SustainAbility Institute by ERM, in a report. And that’s without accounting for ESG-linked loans and bonds, such as those pioneered in the fashion industry by Chanel and Prada, that lower interest rates or premium values if certain sustainability targets are achieved. Investors conducting due diligence frequently use more than one rating and regularly evaluate which ones they use, according to Wong.
Questions continue to mount, however, over the credibility and accuracy of such ratings, especially when so many are jostling for primacy using disparate methodologies and a reliance on voluntary disclosure, which allows brands to more or less dictate the outlines of the narrative they wish to tell. The issue came into focus over the summer, when it emerged that MSCI had given Boohoo a double-A ESG score — distinguishing the British fast fashion e-tailer as above industry average in terms of supply chain labour practices and placing it in the top 15 per cent of its peer group — just before allegations about its promotion of poverty wages and unsafe working conditions in the garment hub of Leicester, England, hit international headlines. (MSCI declined to comment about Boohoo, though it says its ratings are not a recommendation or endorsement of a specific company.)
Investors who purchased Boohoo shares missed a clear “red flag” in the form of the e-tailer’s limited disclosures, particularly when it came to the provenance of its clothing, says Joachim Klement, investment strategist at London financial broker Liberum, which downgraded its rating on Boohoo shares from “buy” to “hold” in the aftermath of the imbroglio. Case in point? The 2020 Fashion Transparency Index gave Boohoo a traceability score of zero in April because it shared no information about where it bought its clothes or sourced its materials. Indeed, Klement adds, ESG scoring is riddled with loopholes that allow companies to “game the system”, since they can choose to divulge only favourable information that can mislead less judicious or experienced investors. Another problem with ESG ratings is they lack oversight — “everybody does it a little bit differently”, says Klement.
Not all ESG indexing firms are created equal. The SustainAbility Institute by ERM characterises two main types of raters. The first, the “active” ones, use questionnaires and surveys to request information from companies, which they then compile to produce a rating. The second, “passive” raters, arrive at a score by either aggregating publicly available data or by conducting assessments based on public or private corporate reporting. Some indices may gloss over missing information from the brands they’re appraising; others say the abridgement of certain information can drag down a company’s score.
The passive approach is not as easy as it sounds. Because there are no unified guidelines, corporate disclosures can align with one or more of several different frameworks, whether it’s the Sustainability Accounting Standards Board (SASB), the Task Force on Climate-related Financial Disclosures (TCFD), the Global Reporting Initiative (GRI) or something else entirely, which means the metrics themselves can be inconsistent and difficult to parse from one format to another. Requirements for ESG key performance indicators, too, can vary widely from country to country. (In France, where Kering is based, listed corporations are required to disclose in their annual reports any financial risks related to the effects of climate change.)
Another limitation of ESG ratings is they are based on past or “backwards-looking” data, creating a snapshot of a brand at a certain point in time rather than where it currently stands or aspires to be. Some critics wonder if a company’s social and environmental performance, with its myriad nuances, can be boiled down into something as reductive as a score, let alone employ it as a point of comparison. And the truth is some methodologies are just more robust than others. “The problem with ratings is that, by nature, they are quite subjective,” says ESG consultant Luna Atamian Hahn-Petersen. “There are different ways of interpreting the data.”
Then there is the fact that the bulk of the fashion industry’s impact occurs across extended and often convoluted value chains. “Looking at company-specific performance and comparing companies with different levels of upstream integration yields meaningless results,” says Bernstein luxury analyst Luca Solca.
Still, proponents of ESG ratings say they can provide more than bragging rights for high-scoring brands. ESG scoring can spur greater transparency in brands, especially luxury ones that are typically loathe to shatter the mystique that is a large part of their attraction. They’re not a “panacea for whether a company is doing the right thing”, but they can provide a start, says Sarah Ditty, policy director for grassroots group Fashion Revolution, which authors the Fashion Transparency Index every year.
For Hugo Boss, which has appeared in the DJSI since 2017 and is featured in the German Stock Exchange’s new DAX 50 ESG Index, ESG ratings serve as an objective assessment tool to quantify its progress over time, compare its performance with its peers and identify areas for improvement in a way that’s visible to multiple stakeholders — “in particular capital market participants”, a representative writes in an email. At Burberry, the ESG disclosure process “drives accountability, helps inform our strategy and supports continuous improvement”, says Pam Batty, its vice president of corporate responsibility.
Beutler at Kering agrees. “We’re constantly looking at ratings and how we can improve on them,” he says. “Where’s the gap? Do we need more data from a certain area? Does that data exist? That’s a discussion we have at least once a week; [the ratings are] not something we look at just once a year. [They’re] a way of having an external view on our performance — just like if you’re a runner and you’re using an app to see how well you’re running.”
One thing everyone in the ESG space seems to agree on is that a form of standardisation would go a long way towards burnishing the reputation of ratings and minimising their pitfalls. Momentum is gathering in that direction: in July, SASB and GRI announced a “collaborative work plan” to align their respective frameworks, a move that Lotte Griek, head of corporate sustainability assessments at DJSI owner S&P Global, says will help “reduce barriers to reporting” while allowing ESG raters to use those disclosures to “produce the most comparable set of scores based on these common standards”. At the same time, Griek sees a value in having different ratings assessments. “There are a range of use cases for ESG scores,” she says. “And the market benefits from a variety of scores using different methodologies.”
Even so, the absence of a strong set of reporting standards or legislation with heft means that ESG reporting remains partial and can only be described as “in its infancy”, much like the state of financial reporting before the introduction of stock market supervising authorities, says Bernstein’s Solca.
Until tougher standards are in place, the ratings landscape will continue to be fractured and undisciplined. “We need the International Financial Reporting Standards of ESG,” he adds.