In April, Professor Jem Bendell wrote an article in Responsible Investor outlining 9 flaws in ESG analysis and ratings Link and highlighting five fixes. In an article on RI last month, I disagreed with almost all of the flaws that he identified, suggesting that they would drive SRI into a niche. In this second article, I argue that problems that do exist in SRI research are plumbing problems that require practical solutions by the industry rather than policy flaws requiring external intervention. In his article, Professor Bendell highlighted a five point agenda for improving SRI analysis. It is these fixes rather than the imagined flaws that really worry me. My objections to these fixes are:
- Fix 1: New training
My response: Training is more likely to alienate than educate mainstream analysts and will create unnecessary barriers for junior analysts
- Fix 2: Codes of conduct for SRI research
Response: The dead hand of such bureaucracy will not help an already over-conscientious industry.
- Fix 3: Open-source analysis
Response: Ill-considered collaboration has caused too much damage in SRI already; commercial competition and the promise of financial return is needed to stimulate investment in high-quality research.
- Fix 4: Higher revenues for code-abiding analysts
Maoist!* Fix 5: New regulation and government funding to guide practice
An SRI GRI run by the PRI. Anyone?
I believe that the fundamental positioning and approach of SRI research is robust and healthy. The techniques and strategies used are sound and offer a wide range of choice to investors with all levels of financial and sustainability requirements. And the industry has found a hugely constructive middle way between the expectations of sustainability activists and the capabilities of companies. The direction and pace of travel towards further integration with mainstream investment analysis is good. However, the SRI industry’s ‘plumbing’ is blocked in a number of places. The flows of information, analysis and money around the industry are complicated, distorted and inefficient. This hinders the majority of committed, intelligent and principled analysts SRI analysts from doing their jobs as effectively as they might and limits the sustainability effect of SRI. It is perhaps unsurprising that the SRI industry’s information and financial flows are inefficient and even blocked. The industry is young and has been fragmented on national lines. Young industries naturally reach for the security of regulation, policy initiatives and collaboration for confidence, rather than allowing the market to shape their direction. SRI is also popular and everyone wants to weigh in and shape its development and social effect. Furthermore, sorting out the basics is in everyone’s interest, but in no-one’s specific interest. It is a classic ‘tragedy of the commons’. However, as the industry emerges from tunnelling through years of resistance into the light of widespread global acceptance, the positive benefits of fixing the plumbing become clearer as does the inevitability of doing so.
Encouragingly, the fixes are simple. They require no intervention from players outside the industry, no additional funding, and the SRI industry could do them all tomorrow.
Professor Bendell quotes Allen White as saying “whether ESG will achieve its full potential as a sustainability driver depends on the standards of transparency, integrity and rigor that govern these rapidly expanding markets”. The final word, ‘markets’ is critical. Allen could have used the word ‘research’ in its place. But he didn’t. He is right that it is the ‘markets’ not just the ‘research’ that must be rigorous and transparent. Bundled services, confused payment channels and mixed messages mean that, currently, they are not.
‘Fixing the plumbing’ therefore means creating an open market through which all providers can supply relevant information and analysis and be paid appropriately.
The conditions that will be required to bring it and the outcomes that can be expected, include:
• Asset managers taking control of their own budgets
• Unbundling of SRI research services
• Fungible research supply and transferable payment
• Transparency in sell-side research payment
• Actively-engaged purchasing by asset managers
• Fewer free services
• Greater contributions by companies
• More integrated analysisAn open market is likely to lead to the following outcomes:
• An acceleration in the commoditisation of SRI data and a further reduction in its cost
• Reduced volatility in the markets for SRI research (as supplied by the sell-side, agencies and others)
• Stronger links between the cost and quality/value of research
• Increased specialism by research providers
• A broader range of research sources and suppliers
• Greater integration with mainstream investment processes
Of course, untrammelled markets do not always (ever?) lead to the best social outcomes. Intervention is still appropriate for stimulating demand, developing creative talent in the next generation of analysts, developing and ensuring transparency standards at point of sale to investors, and early-stage R&D – to explore new areas of SRI activity and develop best practice (the UNPRI’s work on new asset classes falls into this category).
However, to me, the advantages seem to far outweigh the areas where caution is needed and should, when put together, improve the depth and quality of SRI research, improve the SRI industry’s engagement with companies, protect the legitimacy of SRI for the long-term and enable it incentivise and support positive sustainable activity within companies.
Mike Tyrrell is the Editor of SRI–CONNECT and a consultant at Sustainable Investor