Missing the bigger picture? How a coal giant scored better on ESG than a renewables firm (and made the FTSE4Good)

RI talks to Ulf Erlandsson about the lessons that must be learnt from the case of Adani Power

Investors, lenders and data providers can learn big lessons from the case of Adani Power, says Ulf Erlandsson, a former bond trader at Swedish pension fund AP4. In a recent white paper, he delves into how India’s largest listed coal utility managed to bag a sky-high ESG score and was included in a major emerging markets ESG index.

But this is not a story about how coal companies can get it right – it’s one about how the ESG industry can get it wrong.

In the paper – one of the first research pieces out of the newly-launched Anthropocene Fixed Income Institute – Erlandsson states that, in his view, Adani Power, with a coal-based generation capacity of 99.7%, is a better candidate for exclusion than “for best-in-class ESG inclusion”.

Instead, an ESG data aggregator has ranked Adani Power in the 94th percentile – well ahead of companies like Danish renewables giant Orsted (considered the most sustainable company in the world by some others), which falls in the 85th percentile. 

Erlandsson is keen not to disclose the names of the two providers, saying the focus should be on the broader issue, but a quick online search shows that the data aggregator is CSRHub; and a source close to FTSE confirmed that the emerging markets index is FTSE4Good.  

Erlandsson tells RI that, as Adani Power is 77% owned by Adani Group – whose other subsidiaries own the highly controversial Carmichael coal project in Australia, described by Rolling Stone magazine as “the world’s most insane energy project” – any suggestion of strong ESG credentials should be questioned.

Despite these ties, Adani Power qualifies for inclusion in the FTSE4Good Emerging index because it does not actually produce coal, it just burns it. And the index’s coal exclusion policy bars companies that derive the majority of their revenue from coal production.

Erlandsson says the case of Adani Power highlights issues around the effectiveness of production-based exclusions in enabling investors and lenders to allocate capital to truly sustainable companies. He says a more holistic approach is needed, which would appraise Adani Power in its context as one of several “horizontally placed” subsidiaries within the coal heavy Adani Group conglomerate. When viewed like this, he argues, it becomes less tenable to treat Adani Power in isolation and omit it from coal based exclusions.  

“For example, for some, it would be commensurate with coal exclusion policies to invest in Adani Power in a scenario where the company procures its coal from the Carmichael coal mine currently being built in Australia,” he writes. “The actual production could happen in the Adani Australia subsidiary with logistics being provided by the Adani Abott Point and Adani Ports and Special Economic Zones sister companies.”

This example “illustrates the potential lack of bite with production based coal criteria in larger corporate structures,” he continues. 

He tells RI that production-based approaches to coal exclusions “miss the wider chain around coal, which drives demand for the coal mining assets”. 

Complex corporate structures like Adani’s are also “not always perfectly modelled” in ESG ratings either, Erlandsson claims.

“I am sometimes wary when someone offers ESG ratings on 20,000 or even 10,000 companies because, in my experience, especially in the fixed-income space, it is hard to disentangle some of the cross shareholdings and relationships between companies and say that one company is separate from the other.” 

In his paper, he cautions against relying on “ESG ratings based on unsupervised big data or algorithmic approaches”, which, he says, could be “subject to both stratification issues as well as reverse engineering/spoofing”.

It can be expected, he notes, that “companies and other issuers of fixed-income capital will put effort into artificially inflating ESG ratings”.

Bahar Gidwani, Co-founder of CSRHub, tells RI that the ESG data aggregator does not “pretend to uncover the ‘truth’ about a company’s social performance”, but instead seeks “to estimate a consensus view of a company, based on the opinions of all of data sources we can find”. 

He adds that it bases its rankings on 14 data sources, including MSCI, S&P Trucost, and Ideal Ratings.

To be included in the FTSE4Good Emerging index, companies need an ESG rating of at least 2.9 out of five. Last month, FTSE Russell undertook a consultation on enhancing climate change scores in its ESG ratings and FTSE4Good indexes.

Erlandsson, however, tells RI that it is very hard to see why Adani Power should be included in any ESG index if it “cares about climate change or carbon intensity”.

The need to rethink approaches to coal exclusions is also discussed in the paper in relation to plans announced by Adani Power to delist. Taking coal assets private is a move that has been “well-tested in Europe”, Erlandsson writes, but it may serve simply to reduce transparency. Issuers – includes companies and sub-government entities – are “very keen” to “get fossil or unsustainable assets out of the public eye”, Erlandsson tells RI.

A spokesperson for the London Stock Exchange Group, which owns FTSE Russell, declined to comment.