Sustainable investing has quickly become one of the biggest finance trends in America, with a $12 trillion market and steady growth topping $1 trillion annually. Today, it represents approximately one out of every four dollars in total U.S. assets under management. Yet, many would be surprised to learn that the methodologies that guide “sustainability” investment ratings do not always value renewable energy deployment or, for that matter, lower greenhouse gas (GHG) emissions.
In fact, holding all else equal, current Environment, Social and Governance (ESG) methodologies theoretically make it possible for a company investing in coal to receive a higher ESG score than a company investing in carbon-free renewable power – if, for example, the coal company uses more efficient light bulbs in its headquarters. Such fundamental shortcomings in current ESG rating practices must be addressed if ESG investing is to reach its full potential as an effective catalyst for reducing carbon emissions and mitigating climate change.
Q2 hedge fund letters, conference, scoops etc
With the help of more than 30 renewable energy investors and other key stakeholders, the American Council on Renewable Energy (ACORE) recently analyzed the current state of ESG investing in the United States and developed a specific set of recommendations for how ESG ratings can better reflect renewable energy use and investment.
ESG investing and transparency
In our report, we outline how a fragmented marketplace, a lack of transparency in rating methodologies, and a failure to focus on truly material information hinders capital from flowing to the companies that deserve it most.
The methodologies ESG rating agencies use to calculate companies’ scores are not standardized, making it difficult for rated companies and investors to make “apples-to-apples” comparisons. Moreover, ESG rating agencies often do not disclose their methodologies, instead using “black-box” proprietary information to calculate their scores. This lack of transparency stymies corporations attempting to improve their scores, and poorly serves investors seeking relevant and actionable information. Finally, ESG rating agencies often use too many data inputs that have little bearing on a company’s financial or operational performance, thereby distorting the very signal an effective ESG score is designed to send.
To more accurately measure the climate impact of ESG investing, ACORE recommends that ESG scoring entities adopt the following practices:
Best practices
- Enhance Renewable Energy Disclosures. Company disclosures and rating agency scores should include both the amount and method of companies’ renewable energy procurement. In addition to how much renewable energy a company uses, the extent to which a company’s renewable energy procurement puts new pollution-free power on the market – a concept known as “additionality” ― should be more accurately captured in emissions reporting.
- Provide Credit for Avoided Emissions. ESG methodologies must go beyond evaluating a company’s operating carbon footprint to include the downstream impact of its business activities. With an estimated $1 trillion in private capital earmarked for sustainable and low-carbon projects over the coming decade, capital providers should be able to receive credit for avoided GHG emissions attributable to their investment decisions.
- Implement Standardized, Material and Forward-Looking Data Reporting. To provide a more meaningful basis for comparison, ESG scoring should increasingly rely on widely agreed upon data inputs that have a material impact on companies’ financial and operational performance. Such data should include forward-looking analyses capable of holding rated companies accountable for progress over time.
- Adopt a Universal Climate Benchmark. In optimized form, ESG scoring should help accelerate the transition to a decarbonized economy. International initiatives, like the Paris Climate Agreement and U.N. Sustainable Development Goals, can provide a common global benchmark against which companies’ ESG performance can be judged.
Through these practices, ESG investing can provide greater incentives for investment in, and deployment of, renewable power by leading American companies. Such an infusion will be critical to keep the sector growing through the scheduled phase-out of wind and solar tax credits in the early 2020s. Accelerating renewable growth through this period will be essential to keeping the U.S. within striking distance of international GHG emissions reduction targets.
Gregory Wetstone is President and CEO of the American Council on Renewable Energy, a national nonprofit that unites finance, policy and technology to accelerate the transition to a renewable energy economy.
