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Two Steps Forward

Wall Street, ESG and the Wild West

Adapted from GreenBuzz, a weekly newsletter. Subcribe here.

The world of environmental, social and governance, or ESG, reporting in corporate circles and among mainstream investors seems to be growing by leaps and bounds. Each week brings new reports, tools and other developments in the field.

Case in point: Last week, Walmart released its first Environmental Social & Governance Report, which seems to be the new moniker for what had previously been its Global Responsibility Report, signaling a shift in framing the topic by a leading company.

The report melds governance issues — such as average total compensation and number of promotions for hourly full-time associates in U.S. stores, and data on diversity throughout various segments of the company — with key environmental metrics, which now include the volume of plastic Walmart recycled globally, the volume of food waste reduction and metrics on sustainable supplier contracts. 

Walmart’s move reflects the broadening interesting in ESG, what until relatively recently had been of interest primarily to 'impact investors' and their fellow travelers.
Walmart’s move reflects the broadening interesting in ESG, what until relatively recently had been of interest primarily to "impact investors" and their fellow travelers.

No longer. As we reported in our 2018 State of Green Business report, ESG is moving from the margins to the mainstream. And the financial community is ramping up accordingly.

Last month, for example, the Prince of Wales Accounting for Sustainability Project launched a U.S. chapter comprising chief financial officers from a handful of large companies, including Autodesk, Caterpillar, Gilead Sciences, Levi Strauss and Salesforce. They have committed to "take action by being a leading source of knowledge and experience" on aligning financial and sustainability value, and to "use their collective influence to engage, enable and collaborate with the wider CFO and finance communities."

Assessing carbon transitions

And last week, Moody’s, the venerable credit rating company, proposed a scoring framework for assessing carbon transition risk for publicly traded non-financial companies. Carbon transition assessments, or CTAs, are intended to provide a greater level of visibility and transparency into how Moody’s and others assess risk for companies amid the shift toward a lower-carbon economy.

"We are very focused on carbon transition risks and how those risks are affecting all kinds of sectors globally," Jim Hempstead, managing director of the ESG Group at Moody's, explained to me during my visit to Moody’s New York headquarters last week. (My interview with Hempstead can be heard in last week’s 350 podcast.)

"They're affecting different sectors with different speeds and with different scope. And so, a carbon transition assessment tool is an ability to provide a common framework that we can use. It's transparent and verifiable, that we could use across all asset classes and all geographies where we speak with a common approach towards how carbon transition risks can translate into credit risk or business strategies or business opportunities."

Moody’s defines carbon transition risk as the implications of the policy, legal, technology and market changes likely to affect a company in the transition to a lower-carbon economy. They indicate the kinds of risks to which companies may find themselves exposed. They are not credit ratings, and don’t directly affect them, although they could feed into Moody’s overall assessment of a company or its creditworthiness.

"It'll inform our indicator of risk," Hempstead explained.

Moody’s proposed CTA uses a 10-point scale across four key components "that are most relevant to an issuer's ability to successfully manage a shift to a lower-carbon economy":

  • its current business profile;
  • its technology, market and policy exposure;
  • its medium-term response activities; and
  • its longer-term resilience.

Moody’s is seeking comment on the proposed framework over the next 60 days. 

To be sure, the world of ESG is still Wall Street's Wild West. There appears to be no consensus among investors about how to analyze the impact of ESG ratings — a challenge we took up in the GreenFin Summit at our GreenBiz 19 conference in February, and which we’ll reprise and expand upon at next year’s GreenBiz 20.

To be sure, the world of ESG is still Wall Street's Wild West.
Clearly, there’s much more work to do. In another report released last month, the ratings firm MSCI assessed more than 2,000 ESG investment studies to understand "how this has produced a lack of understanding of the link between companies’ ESG characteristics and their financial risk and performance." It found that the methodologies used in most studies were designed to meet social or ethical values "rather than the more essential financial objectives."

MSCI noted: "The most difficult question is whether ESG ratings, in general, have been linked to a risk premium like those of traditional financial factors such as quality, value or momentum."

The answer was inconclusive. ESG ratings have a much shorter history than traditional factors, meaning that the statistical confidence level is fairly low compared to that of other factors. A longer time horizon is needed to authoritatively address this question.

But MSCI observed, "Companies with higher ESG ratings, on average, had lower frequency of stock-specific risks, avoiding large drawdowns and thus representing a ‘risk-mitigation premium.’"

And lower risk can translate to lower cost of capital and higher investor interest. That should be the mantra of every corporate sustainability executive seeking to demonstrate the long-term financial value of what they do.

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