Khartoum’s Presidential Palace was just a short stroll away from the outdoor restaurant where Jeff Quartermaine started scrolling his phone for the latest news headlines.
“This was one anecdote I had on one day of the year and things might be different at other times,” he says. Henry’s concerns, which Quartermaine shares, are similar to the findings published in November by the International Organisation of Securities Commission , which is the global league for regulators like the Australian Securities and Investment Commission.
To understand why governments in Europe and North America are moving toward regulation of ESG ratings agencies, you first have to understand what they do.Firms like Sustainalytics generate most of their revenue by selling subscriptions to institutional investors in exchange for a frank assessment of the non-financial risks that companies are exposed to, and the extent to which companies have systems to manage those risks.
“It is hard to imagine a single ESG score that encapsulates an issuer’s E, S, and G profile, because those things mean different things to different people,” said Kroll’s chief ESG adviser, Pat Welch, in an article published earlier this month. The score places the company on Sustainalytics ESG risk spectrum, which is broken into five categories; negligible, low, medium, high or severe.
But IOSCO warned that conflicts of interest could emerge where ESG ratings agencies also sell other services to the companies that are subject to their ratings.Some ESG rating agencies offer advisory services that promise to help companies improve the ratings they publish; an offer that some executives interpret as a subtle form of blackmail.
Sustainalytics also earns revenue by providing second opinions on the ESG credentials of green bonds; fundraising initiatives that are tied to a particular investment that will create environmental benefit. “Some transparency of methodologies so the people using the ratings have an understanding of what they are seeing and just a basic management of conflicts of interest.”
While ESG rankings matter for all companies they are particularly challenging for mining and energy companies, whose work often takes them into frontier locations and usually requires the disturbance of landscapes to extract the saleable product. Perseus was perilously close to slipping below that mandated threshold in the mind of one ESG rating agency, leaving the investor on the brink of selling.“I had this very lengthy conversation with their fund manager, who expressed great appreciation at the work we had done and said we were doing an excellent job. But he also said if our ESG rating was to fall, he would have to divest the stock, not withstanding the fact we were the top performer in his portfolio,” recalls Quartermaine.
Sustainalytics gave exporters of Australian thermal coal like Whitehaven and Glencore a more favourable ranking than the lithium miners, placing the coal miners in the “high” risk category. “We have seen a dramatic increase in the amount of disclosures coming from companies over the last decade, so that is great, but I don’t think right now the increases we are seeing are fast enough.”
That would make life much easier for ESG ratings agencies – and investors – when trying to compare and contrast the ESG credentials of multiple companies. “Large entities often have significantly more time and resources to complete the multitude of ESG surveys and disclosure requests they receive. Small and mid-sized issuers, on the other hand, do not have the same ability, and they are often penalised for not having the same means to fill out the requested information,” said Kroll earlier this month.Company disclosures can be unreliable, biased, or mask risks. This is where RepRisk can shine a light on these hidden risks.
But those negative indicators were coming to light because of a report that Rio commissioned and published in full with an accompanying vow to fix the problem. “[RepRisk] is something that has been very useful to us over time because it finds things before other people find things.”Glencore boss Gary Nagle says “false reporting” is a common trigger for interaction between his company and the agencies that rate its ESG credentials.