After the release of a new report from Goldman Sachs and Citigroup, many environmentalists are left wondering how Wall Street can be green when it is so involved in fossil fuel companies. The two banks released their findings without any mention of divestment or pushing for alternative investments, which has led to backlash from some activists.
The “wall street journal investing challenge” is a new social media campaign that has been created to show people how easy it is for Wall Street executives to use their influence to push investments into companies that they own shares in.
Green finance is expanding, and an unusual combination of corporations at the center of the financial system is leading the charge.
The global accounting firms that audit the books, assess bonds, advise on proxy voting, and classify the world’s corporations are investing billions in climate-related activities. This might hasten the transition away from fossil fuels, but it could also provide a new set of conflicts of interest for sectors that have hitherto struggled to manage them.
According to an investigation by The Wall Street Journal, financial-services businesses in the United States have spent more than $3.5 billion on green-ratings companies and data suppliers in the last two years. Environmental, social, and governance, or ESG, is becoming a focus for the Big Four audit firms. ESG was a highlight of PricewaterhouseCoopers’ $12 billion investment plan last year.
When the United Nations invited the banking sector to support its efforts to reduce carbon emissions last year, several institutions had to be persuaded. According to those engaged in the campaign, financial services businesses immediately got in.
As corporations aim to cut carbon emissions and better disclose their ESG practices in response to demands from regulators and investors, some firms are betting big on big profits. To diversify their portfolios, the conglomerates have acquired smaller businesses.
According to Verdantix, a U.K.-based research organization, the market for assisting corporations with corporate ESG reporting is worth an estimated $1.6 billion worldwide, and is expected to grow at a pace of 21% per year over the next six years. According to Kim Knickle, a research director at Verdantix, “the growth rate across numerous categories of ESG professional services is really significant.”
The ESG area is a priority of PricewaterhouseCoopers’ $12 billion investment strategy, according to the firm.
Krisztian Bocsi/Bloomberg News photo
Many organizations that grade or analyze corporations on problems such as climate risk also provide services to assist them handle these challenges. Because they are paid by the corporations they grade, many of the organizations giving these ratings, such as credit raters and auditors, already have significant conflicts of interest. According to politicians, conflicts of interest in the credit-ratings sector were one of the causes of the financial crisis.
The growing practice of offering ESG ratings alongside consultancy and other services has created a new set of possible conflicts.
The nation’s largest shareholder advisory group, Institutional Shareholder Services, provides its climate-risk assessments for hundreds of corporations to investors. It also gives advise on how to improve those ratings to those businesses.
In its pitch to the approximately 5,000 organizations it covers, the Rockville, Md.-based agency urges, “Improve ESG Ratings.” “Stand out from the crowd of capital-seeking firms.”
According to Anant Sundaram, a finance professor at Dartmouth College’s Tuck School of Business, the financial services businesses’ many ESG offerings present evident potential conflicts of interest. “They make money by selling their services…to the exact companies they’re meant to be objectively rating and ranking,” he said.
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Steven Friedman, ISS’s general counsel, said the business, which is owned by Deutsche Börse, has taken efforts to resolve possible conflicts of interest in its ESG work, including putting up a firewall between its ratings and corporate-advisory departments. “ISS does not and will not offer any business issuer special treatment,” Mr. Friedman stated.
The majority of ESG raters’ compensation comes from investment firms, who bundle top-scoring businesses into green-branded products that are marketed to investors. According to Hans Taparia, a management professor at New York University, this provides an incentive to award high ESG ratings.
Mr. Taparia said, “If the raters were harsh on enterprises, there would be no items to develop for investors.”
Morningstar Inc., a fund-ratings company, hands out performance awards to corporations who pay for an ESG review.
For an unknown fee, Morningstar’s Sustainalytics business provides firms a “ESG Risk Rating License.” Its website claims, “Showcase that you are rated by a world’s top ESG Rating organization.” Only those who purchase the license are entitled to get a “Top-Rated ESG Badge.”
Freehold Royalties Ltd., a Canadian company with an oil-and-gas business, was one of the badge winners. Everyone does not think the firm is the best. The ratings organization Refinitiv, which is owned by the London Stock Exchange Group, rates it as a “poor” ESG performance, giving it a score of 23 out of 100. A spokeswoman for Freehold Royalties refused to respond.
According to a Sustainalytics spokesperson, Freehold Royalties has a low ESG risk rating—and hence a high score—because it makes the majority of its money from owning property where oil and gas is generated rather than drilling wells. Sustainalytics considers managing possible conflicts of interest to be “critical to the independence and integrity” of its evaluations, she said.
In the highly unregulated ESG industry, regulators are beginning to look at possible conflicts of interest. Many ESG-ratings organizations provide a variety of services, according to the International Organization of Securities Commissions, an umbrella body of financial watchdogs.
It suggested that its members, including the Securities and Exchange Commission of the United States, consider forcing ESG rating and data companies to “identify, disclose, and, to the degree practicable, minimize any conflicts of interest.”
A spokesperson for the SEC refused to comment.
Ratings agencies are fighting prospective new rules. Morningstar informed IOSCO authorities last year that the “existence of any…potential conflicts does not require regulation of ESG data.”
Moody’s Corp., the world’s largest credit rating agency, advised IOSCO that any new standards should enable companies to explain how they deal with conflicts rather than imposing strict obligations.
Investors purchase ESG analyses of corporations from Moody’s, which spent $2 billion last year for climate and natural catastrophe study company Risk Management Solutions Inc. Moody’s also provides similar reports to businesses, claiming that they may help them “seize new chances for value creation” as a result of climate change.
Moody’s claims to have protections in place to ensure the credit rating process’ independence and integrity.
Bloomberg News/Bloomberg News/Michael Nagle
According to Jeffrey Manns, a law professor at George Washington University, credit-ratings agencies’ sales of ESG services create a new, troubling set of possible conflicts.
According to him, companies may feel compelled to purchase ESG advisory services from a credit-rating company in order to preserve a positive connection with that business and protect their credit rating.
Another worry, according to Mr. Manns, is that credit-ratings organizations may be less willing to downgrade corporations that pay them large fees for credit ratings and, now, ESG services. “Rating agencies don’t want to bite the hands that feed them,” he remarked.
A representative for Moody’s said the company has protections in place to ensure the credit rating process’ independence and integrity. “In any element of our company, including ESG, commercial factors have no bearing on our credit ratings,” the official stated.
Rival credit-ratings giant S&P Global Inc. has commercial interests in businesses that can affect companies’ ESG scores. It also issues such scores and sells ESG data reporting, auditing and risk-management services to companies.
S&P is part-owner of a San Francisco-based company called Xpansiv that runs the Aviation Carbon Exchange, a marketplace that allows airlines to buy and sell carbon credits. Airlines’s use of such credits to brand their operations as sustainable has been criticized by environmental groups, among others.
An S&P spokeswoman said the firm is committed to the independence and objectivity of its products and services. S&P has “controls in place to identify and manage actual, potential, or perceived conflicts of interests,” the spokeswoman added.
Jean Eaglesham can be reached at [email protected]
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The “best stocks to invest in 2021 wall street journal” is a new article that discusses how Wall Street’s green push is exposing new conflicts of interest.
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