ESG ratings need common standards as different data provided by various agencies are raising challenges in measuring the performance of investor portfolios from an ESG perspective, especially on the "social" and "governance" components, senior executives from Khazanah Nasional Berhad and OMERS Asia said.
“We use a lot of third-party providers [in the measurement of S and G], and one of the challenges we find is that when you look at X versus Y, the outputs are very different,” said Anand Ramachandran, Singapore-based managing director with Ontario Municipal Employees Retirement System (OMERS) Asia.
Ramachandran made his comments at a panel discussion at AsianInvestor’s 12th Southeast Asia Institutional Investment Forum in Singapore on Tuesday (November 22).
The "E" or the environmental component, or carbon footprint, is easier to measure with data after engaging with portfolio companies, Ramachandran said.
They will aggregate the carbon footprint of companies they invest in, and push companies towards the reduction target the Canadian pension fund sets internally.
While it is still challenging to get data on Scope 3 -- indirect carbon emissions produced across a company’s value chain -- Scope 1 and 2 emissions measurements have become more mature, thus making “E” a relatively easier factor to measure compared with “S” and “G”, Ramachandran said.
OMERS has its own rating standards based on information collected by the pension fund; it also looks at data from various providers.
“We want every one of our companies to be best-in-class. So, we define what is best-in-class and then we have our internal ratings on one to four,” Ramachandran said.
“... it helps us engage with the company and push them to be better in what they are doing. We look at them not just on an absolute basis, but also in terms of where they are in their journey. Is it stable? Are they improving or declining? It helps us with our engagement.”
HARDER TO MEASURE
However, the “S” and “G” components are not as easy to quantify, and there are large differences in how a company is rated by different agencies.
Ramachandran believes it is important for the industry to evolve and agree on common standards for ESG rating.
Agreeing with Ramachandran, Keat Siang Goh, investments director at Khazanah Nasional Berhad, told the panel that apart from inconsistent ratings, sometimes, the rationale of external providers for a rating score can be wrong.
Goh said the top task and challenge for the sovereign wealth fund is to build a system that can add up the carbon footprint of the entire portfolio.
“There are different levels of influence we have on the portfolio, including on indirectly managed funds. So that is going to be one challenge - getting the system and getting all the data throughout our direct and indirect investments,” he said.
As a sovereign wealth fund, Goh noted that Khazanah has a lot of control over some portfolio companies, which makes them a “quasi-insider”. It enables them to know more about one company compared with what a rating agency can get from public disclosures or their own research and engagement.
There were several occasions when the rationale offered by an external agency on the rating of a company was wrong compared with Khazanah's own understanding of the company.
“At first, I was quite cynical about rating agencies because of experiences like this,” said Goh.
“Then I sat back and thought, it's a cliche to say that this is a journey, but it's true. It is a journey for the whole investment community. Perhaps, to criticise rating agencies for not being too consistent or having data that's wrong isn't fair. Because they are also part of this journey,” he said.
“And that goes to the need to really dig into the information to understand what's the underlying data behind it,” he added.
Both Khazanah and OMERS have previously committed to becoming net zero by 2050.
Nevertheless, both Goh and Ramachandran acknowledged that there has been accelerated progress in ESG measurement standards, especially in Asia, with major markets such as Hong Kong, Singapore and India rolling out or planning disclosure regulations.
During the recently concluded 2022 United Nations Climate Change Conference or Conference (COP27), International Financial Reporting Standards (IFRS) confirmed that CDP, one of the leading environmental disclosure platforms, will incorporate the International Sustainability Standards Board (ISSB) IFRS S2 climate-related disclosures standard into its disclosure platform, a milestone in global ESG standards alignment.
ISSB provides global standards for corporate sustainability disclosures. Incorporating ISSB norms into the environmental disclosure platform will standarise data points across that ecosystem.
“This is just critical, because otherwise, as I try to roll up data from my portfolio, I will be wondering what exactly am I rolling up, a bunch of apples, oranges, pineapples? So, I think we are making good progress here,” said Goh.
Priscilla Luk, managing director, head of global research and design for Asia Pacific at S&P Dow Jones Indices, said the industry is looking for more guidance from regulators in areas such as key metrics and minimum requirements.
“I think we definitely want that kind of alignment and work with industry experts to request regulators for guidelines,” Luk, who was also part of the panel, said.
She said she appreciated that there could be differences among different providers, noting the stock of one company can have different ratings from different investment banks because of different assessments, perspectives, and expertise.
It is important to understand the foundation of the ESG scoring and see whether the methodology is aligned with the investor’s objective, Luk said.
Transparency remains very important, she said.
If the ESG ratings given by different providers are transparent enough and the end user can understand the reasons behind the ratings, investors might even find opportunities during the research process, Luk said.