ESG Ratings Are Not What They Seem — Transcript

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1. 0:01Capitalism right now is going through a reckoning.
2. 0:06There has to be a way in which profits and planet align.
3. 0:11ESG in theory should help,
4. 0:13but that's not what is happening today.
5. 0:16Our sustainable investments benefit you
6. 0:19and parts of the world that need it most.
7. 0:22The whole business is built on the idea
8. 0:25that you can invest in companies
9. 0:27that will allow you to do well as an investor,
10. 0:30but also can do some good for the world.
11. 0:32Perhaps the greatest investment opportunity
12. 0:35in modern history.
13. 0:38ESG is now big business.
14. 0:40It represents by some estimations,
15. 0:42something like $35 trillion worth of investments
16. 0:46and in the last two years, it's grown by 15%
17. 0:49and that rate of growth doesn't seem to be stopping.
18. 0:53Underneath this entire system are ratings
19. 0:57that look a lot like the credit ratings of companies,
20. 1:00but are based on completely unregulated data
21. 1:02and one company
22. 1:04has come to completely dominate that business
23. 1:06and that's MSCI.
24. 1:14So even though a lot of people are talking about ESG,
25. 1:17not many know what goes into
26. 1:20making an ESG rating for example
27. 1:22and that rating is what becomes the basis
28. 1:26for decision-making for investors.
29. 1:28ESG ratings focuses in on what's significant
30. 1:31to a company's bottom line.
31. 1:33What we found is that the foundation
32. 1:35of this multi-trillion dollar
33. 1:37new cash machine for Wall Street,
34. 1:39is not at all what it appears to be
35. 1:41and that it's really almost exactly the opposite
36. 1:45of what people think it is.
37. 1:59I'm Cam Simpson,
38. 2:00I'm a Senior Editor and Reporter for Investigations
39. 2:02at Businessweek in Bloomberg.
40. 2:05There are about 160 different companies that sell data
41. 2:08and ratings that report to rate companies
42. 2:10on their environmental, social,
43. 2:12and governance practices or factors.
44. 2:15Because it's a completely unregulated business,
45. 2:17because it's completely subjective.
46. 2:19The ratings can land anywhere across the board.
47. 2:24MSCI's rating system is built on scores
48. 2:26and they're converted into ratings
49. 2:27that look like credit ratings,
50. 2:29AAA, top of the line, CCC, bottom.
51. 2:33By mimicking a credit rating which is regulated,
52. 2:36which is based on regulated data,
53. 2:38MSCI has created kind of an aura of respectability,
54. 2:43an aura of confidence for the investing world
55. 2:46around these ratings.
56. 2:48I'm Akshat Rathi,
57. 2:50and I'm a reporter with Bloomberg News.
58. 2:52I write about all things climate.
59. 2:55MSCI has been around for more than two decades
60. 2:57and it started its life
61. 2:59as a company that would arrange stocks
62. 3:02in an electronic index.
63. 3:03As the company progressed, it found this demand
64. 3:07for ESG metrics, that people were interested in,
65. 3:12not just ensuring that they were making profits
66. 3:15from their portfolios,
67. 3:16but that the companies within those portfolios
68. 3:19were also aligning with society's goals.
69. 3:22And so about 15 years ago,
70. 3:24MSCI acquired a number of companies,
71. 3:27that gave it the ability to be able to create ESG ratings.
72. 3:32MSCI has become the giant in the field.
73. 3:36By one estimate, 40 cents on every dollar
74. 3:39that is spent on ESG ratings, is owned by MSCI.
75. 3:42So, what MSCI does with its ratings
76. 3:45really matters to the entire industry.
77. 3:50So if you're a company, especially a bigger company,
78. 3:52that's included in the S&P 500 for example,
79. 3:55your ESG rating can really significantly
80. 4:00help you in the world,
81. 4:02to get included in one of these funds.
82. 4:04It can lower your cost of capital, which also can help you
83. 4:07and so they're really keen to have good ratings
84. 4:10and so when a company's rating goes up,
85. 4:12MSCI produces an updated report
86. 4:15that shows what the key factors were
87. 4:19that led to the company moving up the ESG ratings ladder,
88. 4:23moving up its score, moving up its rating.
89. 4:26And so I started just with that,
90. 4:29with a list of companies and upgrades
91. 4:32and to see how quickly and how high
92. 4:34some of them could climb.
93. 4:37We found half of the companies,
94. 4:39out of the 155 that we looked at,
95. 4:41got upgraded just for sitting still,
96. 4:44because MSCI changed the way it weighted the score
97. 4:47or changed the methodology
98. 4:49and so their scores went up as a result.
99. 4:51Take McDonald's for example,
100. 4:53its total emissions are those that match
101. 4:56the entire country of Portugal or Hungary
102. 5:00and much of those emissions come from its use of beef.
103. 5:04But when MSCI gave it an ESG rating upgrade in April 2021,
104. 5:09it did that by reducing the rating of emissions
105. 5:14from a mere 5% to nothing
106. 5:17and instead replacing it
107. 5:19with a new initiative that McDonald's had launched
108. 5:22around recycling.
109. 5:25Except, that the recycling initiative came from
110. 5:28installing bins in select locations, in the U.K. and France.
111. 5:33And when we looked at that,
112. 5:34we found that within U.K. and France,
113. 5:37there was either an upcoming regulation
114. 5:39or a threat of a regulation,
115. 5:41which would have forced fast food companies
116. 5:44like McDonald's and others,
117. 5:45to anyway install these recycling bins
118. 5:49and so, McDonald's essentially got a ratings upgrade
119. 5:53for doing the bare minimum that it should have done anyway
120. 5:57and for not being counted for all the emissions
121. 6:00it was putting out into the atmosphere.
122. 6:08And McDonald's is not a singular example,
123. 6:11it's actually quite typical.
124. 6:12When we looked at the 150 upgrades,
125. 6:15nearly half of the companies
126. 6:17got that upgrade in their ESG rating
127. 6:20without even fully disclosing their emissions.
128. 6:25We found the factors that were driving upgrades
129. 6:28over and over again,
130. 6:29were for things like, what MSCI calls corporate behavior.
131. 6:32The other one that also was kind of surprising
132. 6:34was data protection and also the structure of boards,
133. 6:38deemed to be a factor in potentially
134. 6:41having better outcomes for shareholders.
135. 6:43Of the 155 rating upgrades that we looked at,
136. 6:47we found only one where a reduction in carbon emissions,
137. 6:52was cited as a significant factor in the upgrade.
138. 6:55The rating system and the ratings themselves,
139. 6:59create exactly the opposite
140. 7:01of what many investors believe they're looking at
141. 7:04when they see a highly-rated company,
142. 7:07they think that company has strong environmental,
143. 7:09social and governance practices,
144. 7:11in terms of, its impact on the world, its sustainability.
145. 7:14But what they're actually measuring is exactly the opposite,
146. 7:17is the company sustainable?
147. 7:20Is the value to shareholders sustainable?
148. 7:23What's the impact of the world?
149. 7:25Climate change, water shortages, potentially on the company,
150. 7:29it was a hard thing to get our heads around
151. 7:31until we saw it all together in the data.
152. 7:34MSCI is the leading provider
153. 7:36of investment tools in the world
154. 7:38and as such, in our basic raw material
155. 7:41our sophisticated models, big data and advanced technology.
156. 7:47Henry Fernandez is the CEO and Chairman of MSCI
157. 7:51and has been since the founding of the company
158. 7:54and we met Henry at COP26 where governments meet,
159. 7:58but increasingly, businesses have been playing a role
160. 8:02in shaping the conversation around climate change
161. 8:06and how much they are doing to help fight climate change.
162. 8:11We asked him, do you think ordinary investors,
163. 8:15retail investors have any idea
164. 8:17that the entire lens of the system
165. 8:19is the impact of the world on the company
166. 8:21and not the impact of the company on the world?
167. 8:23And he said, no, that they didn't have any idea.
168. 8:25And in fact, he said he thought even investment managers
169. 8:28who were putting together these funds, didn't grasp it.
170. 8:31You know, they're not really concerned
171. 8:33about the impact on the world the investment managers,
172. 8:35their fiduciaries and their interest is in their fees.
173. 8:39He said, he's a libertarian
174. 8:41and that he would like as little government intervention
175. 8:45as possible and wanted to ensure that the use of ESG
176. 8:49would be one way in which he can stop any socialist ideas
177. 8:53from creeping into capitalism at any cost.
178. 8:58This is a permanent change in the way capitalism works
179. 9:02and by the way, we're doing this to protect capitalism.
180. 9:05Otherwise government intervention is going to come,
181. 9:08socialist ideas are going to come and the like.
182. 9:10So it's not against capitalism, it's about,
183. 9:13you know, dealing with the externalities
184. 9:15that are created in capitalism.
185. 9:17Henry Fernandez was born into
186. 9:20an incredibly privileged family in Latin America.
187. 9:23Henry wound up at Stanford, where he decided to get an MBA,
188. 9:28that was really kind of at the height of
189. 9:31the "greed is good" movement on Wall Street
190. 9:34and Henry then decided that he would go into finance.
191. 9:37He ultimately found himself at Morgan Stanley
192. 9:40and Morgan Stanley had a partnership
193. 9:41with a company called the Capital Group,
194. 9:43Capital Group International.
195. 9:45By the start of 2019, it was clear that this massive shift
196. 9:50driven significantly by millennials and their pension funds,
197. 9:55was really going to take hold
198. 9:57and that created demand for investment managers
199. 10:02all over the world to sell investments to the public,
200. 10:06that purported to make the world a better place.
201. 10:10So Henry Fernandez took his bland
202. 10:13kind of back office Wall Street company
203. 10:15and he rebranded it and he's done pretty well from it since.
204. 10:19Your company has had an amazing run
205. 10:21since it was spun off from Morgan Stanley.
206. 10:23What'd you say up 10 times since 2009?
207. 10:27We went public at $18 a share 12 years ago,
208. 10:29and it's $220 today.
209. 10:31Henry appears to be the first ESG investing billionaire.
210. 10:36His shares are now worth about $1.3 billion,
211. 10:39which makes him almost as wealthy as Tim Cook,
212. 10:44the CEO of Apple.
213. 10:45Companies have a hard time,
214. 10:47often time getting their founders,
215. 10:48getting their directors, getting their executives
216. 10:50to invest in their businesses.
217. 10:52Henry has his whole net worth in his business
218. 10:54and basically his board actually said to him,
219. 10:57"We'd like you to sell a little bit of stock Henry."
220. 10:59And Henry said, "I'm not gonna sell stock.
221. 11:01I think I'm going to make three or four times that money
222. 11:04in the next 10 years. Why should I sell any stock?"
223. 11:06ESG ratings have come under the scanner in recent years
224. 11:10and so in this Wild West of ESG ratings,
225. 11:13regulators now are honing in, on figuring out a way
226. 11:17in which they can standardize how ESG ratings are made
227. 11:21and make sure that ESG ratings
228. 11:25don't end up green washing a company's activities.
229. 11:28The Securities and Exchange Commission
230. 11:30has come up with a regulatory agenda
231. 11:32to bring in more regulation,
232. 11:34as far as ESG disclosures are concerned.
233. 11:37It will be critical I think in the next several months
234. 11:40to see what the Securities and Exchange Commission does
235. 11:43and whether or not they're going to crack down
236. 11:46on some of the claims that are really critical
237. 11:49to bolstering ESG investing versus
238. 11:52what ESG investing really is.
239. 11:53Society hasn't changed.
240. 11:54You know, you would have been intolerant
241. 11:56of our transgression a hundred years ago,
242. 11:58except that you didn't know it, it was not prevalent.
243. 12:01Now today you can find out very quickly
244. 12:04if somebody is doing something wrong
245. 12:06and therefore societies tolerance towards that
246. 12:09is very limited.
247. 12:10There's no question that shareholder action
248. 12:13can move companies, can move companies away from things that are,
249. 12:19you know, really driving climate change
250. 12:22or other ills in the world,
251. 12:24but those moments are incredibly rare
252. 12:27and the idea that these funds, investing in these funds
253. 12:30is doing anything to make the world better,
254. 12:32it's really, really hard to see how that's the case
255. 12:37and there is a huge demand from people,
256. 12:39especially young people around the world,
257. 12:41to not have their pensions and their investments
258. 12:44destroy the planet that they live on.
259. 12:46Whether it will be met with anything that's real
260. 12:49is a really hard to answer question.