Cooley: "What’s wrong with ESG ratings?"

We used to introduce links to Cooley LLP with:

Our Cooley boilerplate:

Cooley is one of the big dogs of the VC legal eagle biz. Something like a third of the unicorns on the WSJ's Billion Dollar Startup Club list have used Cooley for one purpose or another.
Additionally, 20 or 21 of the companies on the "Technology Review's 50 Smartest Companies 2017" list have been represented or counseled by the firm. As I said, one of the biggies.

That was when we were looking at the private stuff. Here's their public company blog, Cooley PubCo, August 8:

About a year ago, the Brookings Institution held a panel discussion regarding the role that the SEC should play in ESG investing and invited SEC Commissioner Hester Peirce to speak at the panel. It’s well known, of course, that she is not exactly a fangirl of ESG in any of its manifestations, and she came prepared to engage, armed with a voluminous speech consisting of 10 theses, footnoted to the hilt. One of her theses was that figuring out what “good” means in the context of ESG is very subjective—that’s why, she said, there’s a lot of debate over best ESG practices and that’s especially why ESG ratings firms are so inconsistent in their results. (See this PubCo post.) There may be even more to it than that.  This new paper, ESG ratings—a compass without direction, from the Rock Center for Corporate Governance at Stanford University, looks at ESG ratings and examines issues about their reliability. The authors conclude that, “while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.” 

The authors contend that demand for ESG information—from institutional and other investors, companies, regulators and other stakeholders—is so great that it has “outstripped the ability of suppliers to supply the depth, detail, and accuracy of data required. This is perhaps due to the immense number of factors that plausibly fall under the heading of ESG, the difficulty in measuring ESG factors, and the daunting challenge of determining their impact.” The use of ratings information is also impaired by the “lack of comparability across firms, lack of standards, the cost of gathering information, and a lack of quantifiable information.”

SideBar
This article from the Economist contends that ESG “suffers from three fundamental problems. First, because it lumps together a dizzying array of objectives, it provides no coherent guide for investors and firms to make the trade-offs that are inevitable in any society.” Closing a coal mine would benefit the climate but harm suppliers and workers, the article suggests; one company might make solar panels popular but display corporate governance problems. Ignoring these conflicts, the article suggests, “fosters delusion. The industry’s second problem is that it is not being straight about incentives. It claims that good behaviour is more lucrative for firms and investors. In fact, if you can stand the stigma, it is often very profitable for a business to externalise costs, such as pollution, onto society rather than bear them directly. As a result the link between virtue and financial outperformance is suspect.” Most telling, perhaps, for purposes of this post, the article maintains that “ESG has a measurement problem: the various scoring systems have gaping inconsistencies and are easily gamed. Credit ratings have a 99% correlation across rating agencies. By contrast, ESG ratings tally little more than half the time. Firms can improve their ESG score by selling assets to a different owner who keeps running them just as before.” [Emphasis added.] The article suggests unbundling the three letters, E, S and G, and instead focusing solely on emissions.

To address the need for ESG information, commercial ESG rating services have developed. According to the paper, there are dozens of ratings providers, some of them owned by well-known companies such as ISS, ThomsonReuters, Moody’s and Morningstar. And, it turns out, investment professionals are highly reliant on these services, with surveys showing that up to 88% of investment professionals use third-party ESG ratings as a part of their investment process. The authors cite a bank analysis showing that “over $200 billion was invested in ESG bond funds between 2019 and 2022.”  (According to The Economist, “the titans of investment management claim that more than a third of their assets, or $35trn in total, are monitored through one ESG lens or another.”)....

....MUCH MORE

And should you be in need of a courtroom litigator or three, and can afford them, and find them willing to take you on as a client, they can scare the hell out of opposing parties/counsel and probably jurists as well.