Fault lines appear around ESG ratings

Investors are calling for a more standardized approach to ESG ratings.

Why it matters: Financial institutions are using ESG ratings to analyze current and potential investments with the assumption the ratings are largely accurate and objective, even when that may not be the case.

State of play: ESG ratings are not subject to any reporting standards and often use different data sources.

• Some ESG ratings groups use internal company data pulled from existing customers to develop a standard set of ESG measures.
• Others use a combination: publicly available records for environmental data, like energy use from commercial buildings, and internal company data to measure the social and governance aspects of ESG.
• Some ratings firms are rating ESG risk, while others rate ESG output, says Insight Investment's head of client management and ESG product lead Victoria May.

What we're watching: There is a strong appetite among institutions to back energy and climate companies — the E of ESG — to meet external commitments to emissions reductions or other climate goals.

What they're saying: "The different ratings providers really vary and they all have different businesses. I don't know that calling it a 'rating' is workable and usable because it's at risk of being misunderstood," May tells Axios.

• "I wouldn't go so far as to say it's a pay-for-play, but the actual measurements and data that's supporting these risk ratings is questionable," adds AuditBoard senior adviser and former Gartner analyst John Wheeler. "Ultimately, the greenwashing that's occurring will become exposed and will drive a whole new wave of more specific requirements and scrutiny from regulators and auditors alike."

Between the lines: Financial institutions are playing a trillion-dollar guessing game using incomplete data.