Inside the messy world of ESG indices

Britons, as our colleague John Burn-Murdoch pointed out in an excellent column last week, have long had a quite distinctive attitude towards very hot weather. When heatwaves strike, we — especially we in the media — typically sideline talk of danger and disruption to focus on ice creams and bikinis.

In the past couple of days, however, something seems to have shifted in the national psyche. Local temperature records were smashed yesterday by well over a degree Celsius all over the country, and in several places exceeded 40C — a level never before recorded in this nation. Hundreds of firefighters were deployed to blazes across London as parched vegetation caught alight across the capital.

Some in the UK have long held the view that global warming, while dangerous to those in the tropics, could be rather pleasant on these shores. It is hard to make that argument today. As I write this, the lead item on the homepage of the Daily Mail — a conservative publication that has often downplayed climate concerns — features a montage of fires across southern England, with the headline: “BRITAIN BURNS IN 40C”.

The heatwave has also highlighted a problem that is set to surge up the economic agenda: the need to overhaul infrastructure and buildings to cope with higher temperatures. For a hint of the scale of this looming challenge, see this Twitter thread from Network Rail, which owns the UK’s train infrastructure.

“The climate is changing and this unprecedented weather is hotter than our infrastructure was designed for,” Network Rail said, amid concern that the type of steel used in its rails could buckle in temperatures so far outside the normal range.

As the metal on some of its tracks reached 62C, Network Rail cancelled a swath of services and told customers: “Absolutely DO NOT travel north out of London.”

Across Europe and beyond the climate crisis is becoming more serious and more rapidly than most of us had thought possible. The need for meaningful progress in sustainable business and finance is becoming correspondingly urgent.

Today we look at two important angles on that front. Amid growing scrutiny of the standards applied by ESG indices, FT climate reporter Camilla Hodgson highlights their surprising inclusion of a big thermal coal transporter. And from New York, Ben Glickman considers what surging inflation means for sellers of green-branded consumer goods.

We’ll see you on Friday, when Europe’s scorching heat is due to have abated — for the moment. (Simon Mundy)

How a thermal coal transporter ended up with a sustainable label

Can a company that transports vast quantities of coal, and has reportedly done business with a regime accused of human rights abuses, be considered “responsible”?

Adani Ports — part of India’s huge Adani conglomerate, whose founder Gautam Adani is close to prime minister Narendra Modi — has both of those troubling characteristics. But the company is also found in numerous funds and indices labelled with the “ESG” tag that is supposed to denote the careful consideration of environmental, social and governance issues. 

Adani Ports is included in ESG-labelled indices compiled by MSCI and FTSE Russell and funds that track them. Last year CDP, the non-profit group that runs a global disclosure system for environmental impacts, also upgraded Adani Ports’ “climate change” score for the second consecutive year to a “B”: the second-highest level.

The company remains in these indices even after it was dropped from four of MSCI’s ESG indices last year, when the data provider escalated Adani Port’s so-called “controversy score” to “severe” because of its links to Australia’s contentious Carmichael coal mine. It was also kicked out of the S&P Dow Jones sustainability indices last year following reports that it had business dealings with Myanmar’s military, which has been accused of serious human rights abuses.

So what is going on? The volume of sustainability scores, ratings and everything in between has swelled to unwieldy proportions, amid surging flows into funds branded as “sustainable”. That has brought heavy scrutiny, and a growing backlash against products that analysts and regulators say may not be quite as ethical as their branding might imply.

Adani Ports illustrates how this messy world can work. The company has a huge presence in the transportation of thermal coal, the most polluting fossil fuel. That business is set to contribute more than a quarter of its revenue over the next two to three years, according to rating agency Moody’s.

Yet CDP said the company’s environmental disclosure score had improved because, among other things, it had started reporting on its climate change risks, which it had not done in 2020. A “B” score “does not indicate environmental leadership”, it added.

MSCI’s climate change indices, meanwhile, exclude companies that make money from the mining and sale of thermal coal, but not those that transport it. Adani Ports passed most of the tests for those indices, and would have remained in them were it not for the controversy around Australia’s Carmichael project.

Despite being dropped from the climate change indices, Adani Ports is still in at least two other sustainability focused MSCI indices (the Emerging Markets ESG Enhanced Focus CTB index and the ACWI Low Carbon Target index, according to Bloomberg data). It is also in the FTSE Emerging Asia ESG index and the FTSE4Good Emerging index.

Let’s take a look at one of those: MSCI’s ESG Enhanced Focus index. It requires constituents, among other things, to comply with the UN Global Compact Principles. By signing up to the principles, which Adani Ports did in 2020, companies publicly commit to upholding “their basic responsibilities to people and planet,” and must report on their progress towards this goal each year. 

But the Global Compact website states that the commitment is “not a performance or assessment tool. It does not provide a seal of approval, nor does it make judgments on performance”. The Global Compact also does not verify the information reported by participating companies.

This MSCI index’s rules also include some thermal coal exclusions, but do not prevent Adani Ports from being a constituent. MSCI said the inclusion of Adani Ports in any of its indices was “consistent with the governing methodology rules for that specific index”. FTSE said it did not comment on individual companies, and Adani Ports did not reply to a request for comment.

The smorgasbord of ESG methodologies is an area of growing focus for regulators. Last year, the International Organization of Securities Commissions warned about the lack of “clarity and alignment on [ESG] definitions, including on what ratings or data products intend to measure”.

“There is a lack of transparency about the methodologies underpinning these ratings or data products,” it said.

Index companies insist that they give ample explanation of their processes (see, for example, Moral Money’s recent interview with S&P Global executive Margaret Dorn, explaining the exclusion of Tesla from its S&P 500 ESG index). One challenge they face is the common belief that ESG strategies should aim to pursue positive environmental and social impacts — not mitigate financial risk, as is often the case. As the debate over the purpose of ESG intensifies, index providers will feel the heat as much as anyone. (Camilla Hodgson)

Will inflation derail the green consumer trend?

As consumers feel the impact of surging inflation on their wallets, demand for green products could stand to take a hit.

Most products branded as sustainable come with a price premium, though the difference in price with conventional alternatives varies by product type. And when costs are on the rise, consumers tend to trade down to cheaper products. 

Survey data seems to bear this out. Between September 2021 and March 2022, the proportion of consumers who said they recently bought a sustainable product or service declined in more than a dozen countries, according to data from consultants Deloitte. The cost of those goods was the most commonly cited reason for the change in habits.

Another survey from financial services provider Stifel found that among “lifestyle brand purchasers”, the percentage of consumers who regularly opt for pricier products because of their sustainability was down 5 per cent in May year on year.

“Inflation has pitted what’s sustainable for the planet [against] what’s sustainable for the consumer’s wallet,” said Steve Rogers, managing director of Deloitte’s Consumer Industry Center.

But the reality for sustainable goods in this inflationary environment may be rosier than intuition would suggest, according to Randi Kronthal-Sacco, senior scholar of marketing and corporate outreach at the NYU Stern Center for Sustainable Business. 

Typical consumers of sustainable products are higher income, more educated and more likely to live in urban areas than average, she said. Buyers of sustainable products also tend to be driven by other factors such as environmental or social impact in addition to cost considerations. In short, sustainable products may be more resilient in the face of high inflation.

“Consumers do value those benefits for themselves or for the planet at large,” Kronthal-Sacco said.

Sustainable products also have greater price elasticity than conventional alternatives, according to research by Kronthal-Sacco, meaning consumers are less sensitive to a change in price that comes with inflation. 

Price increases for conventional products have exceeded that of their sustainable counterparts so far in 2022, Kronthal-Sacco said. She attributed this dynamic to the inflationary environment and supply chain snags that have allowed companies to increase conventional product prices faster than in prior years.

So on average the price premium for sustainable goods is shrinking — a trend she expects to continue in the future. (Ben Glickman)

Smart read

• “It’s like a train moving forward”, says Canadian-born climate scientist Corinne le Quéré on the relentless march of global warming. In this thought-provoking interview with the FT’s Henry Mance, le Quéré explores the realities of global warming for politicians and policymakers, arguing that while we have all the tools to combat climate change, we are slow to use them.

---