“You can’t compare an esg rating to a credit rating”

adminonDecember 26, 2022February 19, 2023Leave a Comment

ESG ratings have come under fire for being highly divergent. But a diversity of approaches makes perfect sense, says Dhananjay Phadnis, portfolio manager Fidelity International.

When it comes to choosing a university or buying a car, rankings can help. But what happens when rankings diverge or even contradict each other? This is not just an issue for prospective students or car buyers. In the financial world, the divergence of ESG ratings is a topic of heated debate. "'Profoundly flawed', as a recent cover story in The Economist summed it up. An approach that focuses only on explicitly quantifiable metrics such as emissions has been recommended as a solution.

Meaningful impacts require more than one metric

But such an approach carries dangers, says Dhananjay Phadnis, portfolio manager Fidelity International. At worst, it would abandon improvements in other areas, and at best, it makes perfection the enemy of progress. So what are the challenges of different ESG ratings? "First, the comparison with credit ratings is inappropriate", says Phadnis. These sought to assess one parameter – the probability of default – while ESG ratings consider a variety to derive a rating. The more appropriate comparison, for example, is with U.S. university rankings, where multiple factors (graduation rates, faculty resources, etc.) also play a role.) are taken into account.

Why ESG ratings differ from one another?

A study by the Massachusetts Institute of Technology found correlations between ESG ratings between 0.38 and 0.71, a wide margin. Given the current state of ESG investing, however, Phadnis said there is a strong case for it:

Providers have different views on which factors and with what weighting they impact the E, S or G ranges
The large number of data points used, which includes proprietary datasets and estimates
Whether ratings are applied on a relative basis within a sector or on an absolute basis for the entire universe.

The good side of ratings divergence: the case for diversity

Authorities and organizations have addressed the divergence of ESG ratings. Published papers largely agree that a diversity of views, independent methodologies, subjective assessments, innovation and competition can be beneficial to markets and investors. However, they caution against mechanistic approaches with over-reliance on ESG ratings. If there is a common goal, it is to standardize data.

Simplification to isolate ESG factors is not so easy (for now)

"There are certainly advantages to simplification" says Phadni,s "but even this data-driven approach is not so simple, as seen in the emissions example. Although more than 13,000 companies participate in surveys conducted by CDP, an organization that measures environmental footprints, data on Scope 1 (direct) and Scope 2 (indirect) emissions is still quite sparse." According to MSCI, the disclosure rate for MSCI ACWI members was below 40 percent, while the disclosure rate for Scope 3 (full value chain emissions) was below 25 percent. Trying to collect more complete data could actually lead to more rating differences in many cases, he said. Emissions data providers are attempting to close the data gap using a variety of techniques: estimates, proprietary tools, and company-announced targets.

Focus carries significant risks

For Phadnis, a narrow focus risks missing an important point: Corporate governance and community behavior are also critical to achieving desired goals in other areas, according to the emissions. "Any company that ignores stakeholders will eventually flounder. Purdue Pharma and the opioid epidemic and Nikola and misleading information are just two cautionary tales", says Phadnis.

No substitute for hard work

Over time, efforts to standardize the range of ESG data and improve disclosure would make valuations comparable and increase correlations. Until then, market participants would need to do their homework and understand the process underlying a particular ESG rating. Even better, they develop a robust methodology of their own, according to Phadnis. At the same time, investors should recognize that different ESG ratings also reflect a diversity of views – and that is never a bad thing.

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We, that is the JWP MittenDrin e.V. in Neuruppin, a left-wing alternative house project in a small Brandenburg town. This project emerged in the summer of 1993 from the commitment of approx. 20 young people aged approx. 15-27 years old. They were looking for suitable and affordable living space and a place for an info cafe. After months of unsuccessful attempts to get this concern heard by various institutions, on Friday, 30 September, the Swiss government passed a resolution in favor of Switzerland. July 1993 occupied the house in August-Bebel-Strasse 66. The aim was to create the possibility of self-help and self-initiative. The goal, then as now, was to practice an alternative way of life and living together with people, regardless of skin color, gender or religion.

By our way of life we try to give space to an alternative to the consumer society and to realize the vision of a better world, in order to give short shrift to policy contents (u.a. environmental protection, animal welfare), forms of work, political styles (u.a. direct participation and self-governance, grassroots democracy) and lifestyles (self-responsibility, self-help) to communicate, introduce and live for yourself. Of course, these contents are always evolving and therefore cannot be considered fixed and rigid. After two moves, our association had arrived in the current building. But again our lease ends at the end of the year 2015.

With the purchase of the station we have a future perspective for "after" Created: Not only can we maintain our association and existing structures, but we can also accomplish and achieve more. We want to become a self-governing, socio-cultural and political center. It is important for us to give as many people as possible the opportunity to realize this project. It should be borne by the residents, but also by young people from the city, residents, asylum seekers, political groups and creative individuals. It should be a place of "help to help yourself" and the basis democracy will be. It is also intended to serve as a shelter from the impositions of this society. But until the realization of the project "sociocultural center MittenDrin im Bahnhof" it is still a long way for which we will need a lot of help, also from the city and its citizens: In order to keep the bank loan as low as possible, we are dependent on direct credits/loans and donations. At the same time, we must provide collateral in the form of guarantees. In addition, we need energetic hands and hard-working helpers for the renovation of the station. Donations in kind are of course also welcome. Our fundraising goal is 75.000€ to renovate the house and implement our ideas in it.

Looming storms are likely to shake the stock markets in the fall. (Image: Shutterstock.com/mgequivalents)

Autumn is often stormy, even on the stock markets. Especially in politics, Burkhard Varnholt of Credit Suisse expects some gusts in the coming weeks. Anti-cyclical investment behavior as well as good diversification are necessary, he said.

Since 1917, the U.S. has had a debt ceiling that specifies the maximum amount of government bonds that the U.S. Treasury can borrow. In the past, this ceiling has already been moved up more than a hundred times – usually without much fuss. This is because such a shift or. Suspension of debt ceiling does not increase government spending, nor does it authorize spending for future budget proposals. It simply allows the Treasury to pay for spending that has already been approved politically.

"But given the polarization of American society, increases in the debt ceiling that should be a mere formality are being instrumentalized for political showboating. This could turn into a real problem, because the threat to cut off the government's money supply includes the unlikely but serious collateral risk that the U.S. could default on its government bonds in extremis", explains Burkhard Varnholt, CIO at Credit Suisse Switzerland.

If this were to happen, the consequences would be catastrophic. U.S. government debt is the most important asset in global capital markets. The domino effects of a formal U.S. default would be devastating for the financial system and for the global economy, including the U.S., according to investment strategist. By the end of this month, the U.S. Senate and House of Representatives will have to agree on raising the debt ceiling from the current 22 to a new 28 trillion euros. U.S. dollars to some. Because that's the amount by which recent fiscal legislation has increased the U.S.'s financial needs. But the Treasury may not fulfill obligations already enacted into law until it receives approval from the two feuding chambers of Congress for a corresponding increase in the debt ceiling. "It is quite possible that there will be another government shutdown there in 2021. Certainly Republicans and Democrats will then blame each other for this. In the end, it's the state employees who lose out – and the country loses its international reputation", warns Varnholt.

Protective mechanisms against "accidental insolvency

Two safeguards are designed to protect the U.S. from "accidental insolvency" preserve. First, the U.S. Treasury is allowed to take "extraordinary measures" in times of government stalemate Take action to gain liquidity and time. To that end, the nonpartisan Congressional Budget Office (CBO) creates financial plans each year to show policymakers how long money and time would last in an emergency scenario. This year, however, these calculations are less reliable than normal because of the pandemic, warns the CBO and U.S. Treasury Secretary Janet Yellen. Raising the debt limit, therefore, is necessary to prevent delinquencies on government spending and a default on government debt, it said.

Second, the Federal Reserve (Fed) would intervene if such a default were imminent. If necessary, a country that is in debt in its own currency can print any amount it wants to pay off the debt, says Varnholt: "However, creditors would then avoid this currency for a very long time. It is likely that, in an emergency, the Federal Reserve would temporarily assume the Treasury's financing needs in full through a specially created facility." This would amount to indirect monetization and would be in a legal gray area. But it would be the lesser of two evils politically. Nevertheless, such an intervention would have high costs: downgrading of AAA ratings, rising cost of capital, volatility in foreign exchange and financial markets, to name only the obvious ones.

Further government shutdown expected

Since 1980, government shutdowns have occurred nine times in the U.S. For the most part, the government has been limited to intervening in "non-systemic" business areas business areas, such as museums or national parks, and put employees on compulsory unpaid leave. But in the last shutdown of the federal administration in 2018/2019, a total of 800,000 state employees temporarily received no pay – including 420,000 from "systemically important areas" such as the police, fire department or school system.

"Despite the political and socioeconomic toll of such government shutdowns, the narrow majority vote suggests that the ill-fated game of vabanques will repeat itself in the coming weeks with an unknown outcome. In this tug-of-war, the controversial second infrastructure package on 2.5 trillion US dollars play a role", says Varnholt.

An autumn storm seldom comes alone

In addition, the CIO can already see other storms brewing. He expects turbulence in the event that Fed President Jerome Powell is unexpectedly not re-elected next spring. He is more relaxed about the German elections: "Stock markets reflect expectations of corporate profits, interest rates and currencies – and party platforms usually have less influence on these than is often assumed. Either way, a coalition of at least three parties seems likely in Berlin, which the markets again like because it ties the hands of politicians.", says Varnholt.

He also expects that further waves of refugees from Afghanistan and other trouble spots are likely to be felt on the stock markets as well. This could move the currency markets, weigh on the euro and once again strengthen the appreciation pressure in the Swiss franc.

For investors, good diversification and a countercyclical investment process paid off in particular in the face of the gathering storms.