Is ESG a ‘scam’? Why Tesla Technoking Elon Musk may have a point
By Jenal Mehta
14:00, 27 May 2022
Is ESG a scam? The environmental, social and governance (ESG) ratings attached to stocks by ratings agencies are supposed to measure the performance of companies on those three metrics. And they have real influence. As part of the most recent rebalance of the S&P 500 ESG index, Tesla was disqualified due to its relatively poor score and Tesla’s share price suffered.
This ignited Elon Musk to share his far-too-honest views on ESG, calling it a “scam”. A closer look at the methodology of ESG scoring and indices suggests he has a point.
S&P announced last week that Tesla (TSLA), along with Berkshire Hathaway (BRKb), Johnson and Johnson (JNJ), Chevron (CVX) and Meta (FB), had been removed from their ESG index as part of the recent rebalance. It said that Tesla in particular had fallen short of its peers.
There is no doubt that impact investing is on the rise, investors are seeking out companies who are making a change regarding their environmental, social ad governance practices. This is evident in the increase in capital flows going towards companies who are making such changes.
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Why was Tesla booted off S&P 500 ESG Index?
S&P released a statement this month saying that Tesla (TSLA), along with Berkshire Hathaway (BRKb), Johnson and Johnson (JNJ), Chevron (CVX) and Meta (FB), have all been excluded from the S&P 500 ESG Index as part of the most recent rebalance.
Regarding Tesla, the statement said that “while Tesla’s S&P DJI ESG Score has remained fairly stable year-over-year, it was pushed further down the ranks relative to its global industry group peers.”
Tesla was described as making efforts, but falling short: “While Tesla may be playing its part in taking fuel-powered cars off the road, it has fallen behind its peers when examined through a wider ESG lens.”
The S&P report says it also took into account “involvement in a controversial incident, identified two separate events centered around claims of racial discrimination and poor working conditions at Tesla’s Fremont factory, as well as its handling of the NHTSA investigation after multiple deaths and injuries were linked to its autopilot vehicles.”
Investors want their ESG
Companies have increased investment in ESG practices in recent years. Big tech companies like Microsoft (MSFT), Apple (AAL) and Google (GOOGL) all state ESG targets on their websites. Even energy companies like Shell (RDS) and BP (BP) take part in these disclosures.
Aniket Ullal, head of ETF data and analytics at CFRA Research told capital.com via email that the reason behind the increase in companies investing in ESG practices and disclosures is due the demand coming from the investors themselves who are interested in impact investing.
“Younger investors and employees are increasingly placing importance on company values in their investing and employment decisions. Therefore companies do have an incentive to focus on ESG.”
James d’Ath, ESG director at Edison Group, agrees. In an email interview he told Capital.com: “The more mainstream ESG disclosures become, the more emphasis companies and their investors place on using them.”
How do ESG ratings benefit companies?
“Companies are focused on increased ESG disclosure because capital inflows are increasingly being directed towards firms that have higher ESG transparency and scores,” Ullal says. “For example, in the last one year, assets in ESG ETFs have been growing faster than in the broader ETF industry. As ESG ETFs gather assets, firms have an incentive to score higher on ESG metrics so they get included in these ETFs and can attract capital.”
He expects growth in this area to continue.
How reliable are ESG ratings?
ESG ratings gave a score to a company’s ESG practices. This gives investors a method of measuring and comparing each company’s performance in this area.
Most of these ratings are arrived at by analysing the disclosures that companies make themselves. But those disclosures are not governed by regulations – which means they are not truly comparable.
“I think there is a great deal of room for improvement with the generic ESG ratings methodologies,” d’Ath says. “For example, S&P have a questionnaire which takes 200 hours to complete in full. There remains a bias to companies who have the in-house resource and capacity to disclose in a particular way.”
Ullal also believes there is room for improvement “We are still very much in the early innings of ESG-related ratings and investing. The key is that ESG ratings methodologies should be transparent, clearly documented and consistent. Over the next few years we can expect these frameworks to get refined, particularly on the S and G components, since the E component is more measurable and trackable. Current ratings are useful but there is scope for these frameworks to be refined.”
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