If you own stocks, chances are you’ve heard the term ESG. It represents the environment, social and governance, and it’s a way to praise business leaders who take sustainability – including climate change – and social responsibility seriously, and to punish those who don’t. do not.
In less than two decades for a United Nations Report drawn attention to the concept, ESG investing has become a $ 35 trillion industry. Fund managers oversee one third of total US assets under management said they used ESG criteria in 2020, and by 2025, global assets managed in portfolios labeled “ESG” should reach $ 53 trillion.
These investments have gained momentum in part because they respond to the growing desire of investors to have a positive impact on society. By quantifying a company’s actions and performance on environmental, social and governance issues, ESG metrics offer investors a way to make informed business decisions.
However, investor confidence in ESG funds can be misplaced. As academics in the field of supply chain management and sustainable operations, we see a major flaw in the way rating agencies, such as Bloomberg, MSCI and Sustainalytics, measure companies’ ESG risk: the performance of their supply chains.
The problem of ignoring supply chains
The operations of almost all companies are supported by a global supply chain which consists of workers, information and resources. To accurately measure a company’s ESG risks, its end-to-end supply chain operations must be taken into account.
Our recent review ESG metrics show that most ESG rating agencies do not measure the ESG performance of companies from the perspective of the global supply chains that support their operations.
For example, Bloomberg ESG measurement lists the “supply chain” as part of the “S” (social) pillar. By this measure, supply chains are treated separately from other elements, such as carbon emissions, the effects of climate change, pollutants and human rights. This means that all of these, if not factored into the ambiguous “supply chain” metric, reflect each company’s own actions, but not those of their supply chain partners.
Even when companies collect the performance of their suppliers, a “selective reporting” can arise because there is no unified reporting standard. A recent study found that companies tend to flag environmentally friendly suppliers and hide ‘bad’ suppliers, effectively “greenwashing” their supply chain.
Amazon’s figure does not reflect emissions generated by its many third-party sellers and their suppliers that operate outside of the United States
Another example is carbon emissions. Many companies, such as Timberland, have claimed great success in reducing emissions from their own operations. Yet the emissions from their supply chain partners and customers, known as “Scope 3 broadcasts, ”Can remain high. ESG rating agencies have not been able to adequately include Scope 3 issues due to a lack of data: Only 19% of companies in the manufacturing industry and 22% in the service sector disclose this data.
More generally, without taking into account a company’s entire supply chain, ESG metrics do not reflect the global supply chain networks on which businesses large and small today depend for their operations. daily.
Amazon and the third-party vendor problem
Amazon, for example, is part of the ESG funds the biggest and favorite farms. As a company bigger than Walmart in terms of annual sales, Amazon reported emissions from shipping that are only A seventh from Walmart. But when researchers from two advocacy groups looked at public data on imports, they found only about 15% of Amazon ocean shipments could be followed.
Additionally, Amazon’s figure does not reflect emissions generated by its many third-party sellers and their vendors that operate outside of the United States. a large percentage of its turnover comes from third-party suppliers, approximately 40% of which sell directly from China, further complicating emissions tracking and reporting.
Another important ESG measure concerns consumer protection. Amazon prides itself on being “The world’s most customer-centric company. “However, when its customers have been harmed by products sold by third-party sellers on its platform, Amazon has argues that it should not be held responsible for damages, as it functions as an “online marketplace” bringing together buyers and sellers. Amazon’s foreign third-party sellers are often not subject to US jurisdiction so cannot be held responsible.
Yet major ESG rating agencies do not appear to reflect supply chain involvement in protecting customers when measuring Amazon’s supply chain performance.
For example, in 2020, MSCI, the largest ESG rating agency, upgraded Amazon’s ESG rating from BB to BBB, reflecting its strength in areas such as corporate governance and data security, despite his consumer liability risk.
These differences are also of concern for the ratings of companies such as 3M, ExxonMobil and You’re here.
Other countries are adding pressure
Currently, there is no unified reporting standard, so different companies can select certain ESG performance metrics to report in order to improve their sustainability and social ratings.
To improve consistency, the next step would be for ESG rating agencies to redesign their methodology to take into account what may be environmentally harmful and unethical operations across the entire supply chain. global. ESG rating agencies could, for example, create incentives for companies to collect and disclose the activities of their supply chain partners, such as Scope 3 issues.
In June 2021, the German Parliament adopted the Supply Chain Due Diligence Act, which will come into force in 2023. Under the new law, large companies based in Germany will be responsible for social and environmental issues arising from their global supply chain networks.
This includes the prohibition of child labor and forced labor, as well as attention to occupational health and safety throughout the supply chain. Those who break the law face a fine of up to 2% of their annual income.
The new European Union Sustainable Finance Disclosure Regulation, which came into effect in March 2021, adds a different pressure. It requires funds to disclose details of how they incorporate ESG features into their investment decisions. This led some fund managers to drop the sentence “Integrated ESG” from some of their assets, Bloomberg reported.
Without similar laws in the United States, we believe ESG rating agencies could fill an important gap. Of course, analyzing the ESG performance of a company’s entire supply chain is much more complex. Yet, by linking all ESG dimensions to the end-to-end operations of a company’s supply chain, rating agencies can push business leaders to take responsibility for actions throughout their business chain. supply that would otherwise be kept in the dark.
A version of this piece was originally posted on The Conversation.