Study sounds alarm on ESG metrics

A study by Dr. Bryce Tingle of the University of Calgary, released in late August, has exposed major issues with the environmental, social and governance (ESG) ratings that are increasingly influencing trillions of dollars in investment decisions. Tingle is a professor of law and the N. Murray Edwards chair in business law at the University of Calgary.

The study, titled "A Lawsuit Waiting to Happen: The Use of Non-Financial Metrics by the Investment Industry.' The research provides a comprehensive analysis of the ESG ratings industry and its impact on corporate behaviour and investment returns. Dr. Tingle's research reveals that ESG ratings suffer from conceptual confusion, lack consistency between rating agencies, and fail to predict important outcomes like environmental compliance or financial performance.

The recent policy paper from the Fraser Institute, authored by Bryce Tingle, could have significant implications for the mining sector. This study critiques the reliability of ESG ratings, which are currently driving trillions in investment decisions. As a result, the mining industry may need to reassess its approach to ESG practices and reporting.

"ESG ratings do not measure what most people think they measure. They are not actually evaluating a company's impact on stakeholders or the environment. Instead, they attempt to gauge how external ESG factors might affect a company's bottom line - but they don't even do that successfully," Dr. Tingle said.

The study found that ESG ratings of the same company often vary widely between different agencies, with correlations below 50% compared to 99% for credit ratings. Dr. Tingle argues this indicates the ratings are not capturing anything meaningful about corporate ESG performance.

Even more concerning, the research shows ESG ratings fail to predict future environmental violations, accounting issues, or stock performance. High ESG scores were even associated with more aggressive accounting practices in some cases.

"Investment managers have a fiduciary duty to act in the best interests of their clients," Dr. Tingle noted. "Using these deeply flawed ESG ratings to guide investment decisions is likely a breach of that duty."

The study concludes that regulators should make it clear that reliance on current ESG ratings is incompatible with investment managers' legal obligations. It also calls for closer scrutiny of ESG marketing claims by investment funds.

With ESG investing now representing over $3 trillion in assets globally, the implications of this research are profound. Dr. Tingle's study provides a wake-up call for the investment industry and policymakers to reassess how ESG factors are evaluated and incorporated into decision-making.

Implications of study for mining sector

The study's findings could lead to a shift in investment decisions within the mining sector. Companies that have heavily relied on ESG scores to attract investment might face challenges, while investors may become more cautious about using these ratings as a primary factor in their decision-making process for mining stocks.

The legal risks highlighted in the study could have far-reaching consequences. Mining companies that have prominently promoted their ESG scores might face potential legal challenges if these scores are deemed unreliable. Fund managers investing in mining stocks based on ESG ratings could also face legal risks related to their fiduciary duty.

The study's findings may necessitate changes in how mining companies communicate their ESG efforts to investors. There could be a shift towards focusing on concrete actions and measurable impacts rather than relying on potentially flawed third-party ratings.

If ESG ratings are indeed deemed unreliable, mining companies might need to invest in developing alternative ways to demonstrate their ESG performance. This could have cost implications for the industry.

The market valuation of mining companies could also be affected. The study might lead to a reassessment of how ESG factors are weighted in the valuation of mining companies, potentially impacting stock prices and investment strategies.

Policy-making bodies might reconsider how they incorporate ESG metrics into decisions affecting the mining sector. This could lead to changes in regulations and government policies related to mining operations and their environmental and social impacts.

Lastly, mining companies might need to engage more directly with stakeholders to demonstrate their ESG performance, rather than relying on third-party scores. This could result in more meaningful and substantive ESG practices in the long run, potentially benefiting both the industry and its stakeholders.

The full study is available here.