Climate transition will depend on carbon price not ESG ratings, says Aviva’s Waygood

The OECD is due to issue a policy framework on ‘transition finance’ by 2022

A robust carbon price is the “most important datapoint currently missing” from efforts to decarbonise the global economy, Aviva’s Chief Responsible Investment Officer Steve Waygood has said, urging governments to prioritise carbon pricing as they develop tools to transition the economy. 

Speaking at an OECD roundtable on the role of ESG investing in addressing climate change this morning, Waygood said: “What we need from a valuation perspective is clarity around the forward cost curve for carbon pricing; it is only when we have a carbon price which reflects the external costs of climate change that markets will work.” 

“At the moment, the biggest market failure is that the cost of capital does not reflect the full cost of carbon – and that can only be corrected through government policy.”

Waygood, who oversees responsible investment activities at £348bn UK asset manager, Aviva Investors, continued: “ESG ratings are not the solution to managing the transition. They were never designed for the SDGs or the Paris Agreement, but instead focus on material information to enhance the investment process and improve risk-adjusted returns.”

Carbon pricing involves assigning a cost to companies’ emissions through a tax or market. The latter, known as an emissions trading system (ETS), requires firms to buy and sell carbon ‘allowances’ or ‘credits’, and is widely seen as the most promising market-based mechanism to lower global emissions.

But current carbon prices – $73.18 and $6.93 per tonne under the European and Chinese ETS’ last month, respectively – are much lower than needed to influence the business decisions of big emitters. A Goldman Sachs analysis estimates that a price of more than $100/tonne is needed to reduce global emissions by 50% with current technologies.

The Austrian government announced yesterday that it plans to raise €18bn by 2025 via a new tax on carbon, which will in turn be redistributed to residents as part of a ‘climate bonus’ in the form of tax cuts and annual payments. The tax is set to kick in at €30 per tonne of carbon from next year, and will rise to €55 per tonne in 2025. The move comes after a proposed fuel tax by the French government was scrapped in 2018 after nationwide protests, driving many governments to rethink methods of taxing emissions, to avoid hitting end consumers too hard.

Waygood’s comments were made in conjunction with the launch of two OECD reports: one of which presented research on the state of play within the ESG ratings market, while the other proposed policy recommendations to strengthen the comparability and standardisation of ratings and will feed into an ongoing G20 initiative, co-chaired by the US and China, to develop a sustainable finance roadmap.

OECD Secretary General, Mathias Cormann, criticised data providers’ fragmented approaches to ESG ratings and analysis in his opening remarks at the event, saying:  

“The diversity [in ESG ratings] has hindered the effective pricing of capital and slows the necessary alignment of the market to Net Zero pathways. Our report found that scores across major providers lacked consistency, and too often environmental scores were not even consistent with lower carbon emissions and intensity.

“As a consequence, some portfolios with high environmental scores actually have a higher carbon footprint than existing market benchmarks. While ESG scores can incorporate forward-looking climate transition plans, the mechanism to monitor and engage corporate boards remains underdeveloped. In the face of such challenges, the policy community must collectively take action to strengthen market practices.”

To address this, Cormann said the OECD will develop a policy framework with “definitions, principles and due diligence guidance on transition finance” by 2022, and look into updating the OECD Guidelines for Multinational Enterprises – a key reference for global best practice on responsible business conduct.

Cormann also proposed a new initiative to “assess and report on explicit and implicit carbon pricing efforts” globally as part of efforts to push for more ambitious climate action by countries, while avoiding “counterproductive distortions” such as carbon leakage and trade tensions. No other details were provided.

Notably, while Cormann commended the “strong leadership” of the US in its role as co-chair of the G20 Sustainable Finance Working Group, he did not acknowledge China, the group’s other lead. The two countries have been at loggerheads in recent months in a conflict which could spill over to upcoming climate negotiations at COP26 later this year.

In response to calls to regulate ESG ratings, MSCI’s sustainability chief Remy Briand – the only provider represented in the discussion – said that the focus should be on improving disclosure of the company-reported information that underpins such ratings, and developing ‘best practices’ for providers.

“Using emissions as just one example, roughly 40% of companies in the global investable universe have disclosed Scope 1 and 2 data, which is still relatively low, so there is definitely a need for better transparency on disclosure from companies,” Briand said.

“We think there is also a need to develop best practices for measurements [ESG ratings] as not all products are trying to solve the same problem, so clarification on best practices would be a necessary improvement.”

Calls to regulate ESG ratings have grown in line with the demand for ESG investing, and are increasingly championed by regulators. In Europe, French and Dutch regulators have proposed that all ESG data providers are subject to mandatory regulation by the bloc, while EU financial regulator ESMA has described the ratings market as “fertile ground for potential conflicts of interest” and has itself backed calls to regulate ESG data products in a letter to the European Commission earlier this year.

Separately, global regulators through the International Organisation of Securities Commission (IOSCO) launched a consultation in July on the topic.