Why financial institutions should use ESG benchmarking | by Ari Joura, PhD | February 2024

Peer comparison is often the best comparison

By assessing how well a company is doing compared to its peers, one can better identify which one is worth investing in. Image created by Leonardo AI

The financial world loves to quantify things. It’s only natural that bankers, asset managers, traders and quant companies would find a way to put numbers to non-financial data.

As environmental, social and governance (ESG) reporting requirements become the norm for many industries around the world, a wealth of such non-financial data is available. The first – and understandable – reaction of financial institutions was to consolidate all this data into a single score. If two companies were doing similarly well financially, more investment would go to the company with the better ESG score. Some financial institutions categorically avoid investing in companies with particularly low ESG scores.

The problem is that there is no standard methodology for ESG scores. So each ESG data provider, analyst firm and rating agency creates its own score based on its own values ​​and criteria.

The result is a wild west for ESG scores. A business can receive a top score from one source and a terrible score from another in the same year. Not only do companies not know what to do about it – it’s quite difficult to draw conclusions from findings like “we may or may not cause environmental disasters”. Their financial backers also don’t know whether to continue investing in these companies or not.

To some extent, this difference in scores is not surprising. Standardized ESG data is itself a a recent phenomenon. ESG was first introduced to the world in the mid-2000s, and reporting frameworks didn’t really hit the mainstream until the mid-2010s. Given the complexity of the subject and the fact that the world is just starting to figure out how to produce this data, it’s only natural that it can take some time , before you figure out how to process them.

They exist more problems with ESG scores than just differences in methodology. Some of them cannot be solved even with ESG; however, they are easier to manage when the data is not put into a single number.

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