ESG Ratings: A Call for Greater Transparency and Precision

Jason Halper is Partner, Timbre Shriver is an Associate, and Duncan Grieve is Special Counsel at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Ms. Shriver, Mr. Grieve, Sara Bussiere, and Jayshree Balakrishnan. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian Bebchuk, and Roberto Tallarita; For Whom Corporate Leaders Bargain (discussed on the Forum here) by Lucian Bebchuk, Roberto Tallarita, and Kobi Kastiel; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy – A Reply to Professor Rock (discussed on the Forum here) by Leo Strine; Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) by Lucian Bebchuk, Roberto Tallarita, and Kobi Kastiel; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark Roe.

In early 2022, the ESG ratings industry attracted attention when electric vehicle manufacturer Tesla Inc. was dropped from the S&P 500 ESG Index. Explaining its decision, S&P cited perceived deficiencies in many ESG areas, including Tesla’s lack of an internal low carbon strategy for reporting and reducing carbon emissions, insufficient codes of business conduct, claims of racial discrimination and poor working conditions at a California factory, and poor handling of a federal investigation into deaths and injuries linked to Tesla’s autopilot vehicles.[1] Tesla was not dropped from other comparable ESG indexes.[2]

The differing treatment of Tesla from an ESG rating perspective highlights several realities about the ESG rating industry: first, the fact that ESG ratings providers use different ranking methodologies often results in assigning divergent rankings to the same company. Second, lumping all of “E” and “S” together—or, at times, all of the different issues within each of these categories—can obscure the reason for a particular company’s ESG rating. The at times low correlation among ranking scores, the lack of granular information as to the basis of the rating, and, more generally, concerns around the transparency of ratings processes have led some to question the value, or how to best make use, of ESG ratings. Confusion and controversy can exist even with respect to ratings conferred by a single ESG ratings provider. Industry commentators, for instance, have raised questions regarding the S&P 500 ESG Index’s inclusion of companies such as ExxonMobil and McDonald’s (the latter of which generated more greenhouse gases than Portugal or Hungary in 2019) and the exclusion of Tesla and technology companies such as Meta.[3]

A major contributor to this situation is that ESG ratings providers use a variety of sources of data, methodologies, and formulae to arrive at their ultimate ESG scores. They present their data using different scales—some using letter rankings with others providing numerical scores—causing difficulty when trying to perform one-to-one comparisons between ESG ratings providers. Some ratings providers rely solely on publicly available information as their source data, whereas others rely on questionnaires and feedback from companies directly, which may include material information not otherwise available to the public, in addition to information that is publicly available. A 2021 EY survey revealed that 46% of asset managers viewed the lack of daily information to be a limitation on the value of ESG data,[4] however few ratings providers update their data on a day-to-day basis. These different methodologies and approaches have led to poor correlation among ESG ratings.[5] One consequence is even greater proliferation of rankings: a 2021 report found that 20 of the 50 largest global asset managers use data from four or more ESG ratings providers in order to make informed decisions about their sustainable finance products.[6] The same report found that 30 of the same asset managers have developed their own proprietary internal ESG ratings systems.[7]

Further, there is growing recognition that most ratings do not assess companies’ sustainability profiles, but instead are based on the impact of climate change on a company’s anticipated financial performance: “[R]atings don’t measure a company’s impact on the Earth and society. In fact, they gauge the opposite: the potential impact of the world on the company and its shareholders.”[8] If an ESG ratings provider concludes that “climate change neither poses a risk nor offers ‘opportunities’ to the company’s bottom line,” it may issue a higher ESG rating that is not necessarily reflective of that company’s sustainability efforts.[9]

As discussed in our article “Climate Risk Is Investment Risk”: The Asset Management Industry Confronts The Challenges and Opportunities Presented By Climate Change Transition, asset managers face challenges when assessing the sustainability of their investments and then disclosing those characteristics to investors due, in part, to the lack of coherent ESG ratings based on consistent and reliable criteria and methodologies. There are currently more than 600 ESG standards and frameworks, data providers, and ratings and rankings, provided by a mix of established credit ratings agencies and data vendors, along with niche providers. At present, there is very little consistency across ESG ratings providers and no established industry norms relating to disclosure, measurement, transparency and quality. This poses challenges to investors and fund managers seeking ESG investment opportunities and, at worst, raises concerns that the lack of consistency may facilitate greenwashing. These challenges are only likely to increase as ESG assets are estimated to reach $53 trillion by 2025[10] and risk outstripping the capabilities of existing ratings providers. In this area, many investors prefer active investment strategies and “want managers to use active security selection to uncover ESG opportunities and active ownership to engage and influence investee companies.”[11] One commentator estimates there are approximately 240 ESG-focused ETFs in the U.S. alone, and over 500 ESG-focused ETFs in Europe.[12]

Regulators in the U.S., UK, and EU recognize this as an important issue and are starting to develop rules in this area. In the U.S., the Securities and Exchange Commission (“SEC”) is pushing to standardize climate-related disclosures by public companies which, it is hoped, will have a positive knock-on impact on the accuracy of ESG ratings.[13] In the EU, the European Securities and Market Authority (“ESMA”) is considering increased regulation of the ESG ratings sector.[14] In the UK, the Financial Conduct Authority (“FCA”) has opined that low correlation among ESG ratings is not, in itself, harmful, as long as ratings providers are transparent about their methodology and the data they use and have robust governance processes.[15] The Board of the International Organization of Securities Commissions (“IOSCO”) has also published recommendations for ESG ratings providers.[16] Industry bodies such as the International Financial Reporting Standards Foundation recently launched the International Sustainability Standards Board, aimed at delivering “a comprehensive global baseline of sustainability-related disclosure standards that provide investors and other capital market participants with information about companies’ sustainability-related risks and opportunities to help them make informed decisions.”[17] The common theme across regulators and industry bodies is a push toward increased transparency. This approach is backed by research that transparent disclosure standards and publicly accessible data is the solution to fight the “noise” from conflicting ESG ratings.[18]

ESG ratings are likely to remain in the spotlight given their importance for investors, issuers and policymakers. It remains to be seen whether the current ESG ratings ecosystem can be simplified through regulatory measures or broader market consensus. More consistency would certainly benefit investors and companies focused on sustainable initiatives. Another approach might be for ratings providers to unbundle and separately rank companies according to the “E,” “S,” and “G” (some ratings providers, such as S&P, do currently provide such disaggregated information), thereby providing investors with more targeted assessments and therefore more useful information.  After all, different investors may, for instance, place different weight or value on a company’s ability to manage climate change transition versus its workplace environment. One commentator has observed, for example, that certain technology companies score highly in ESG ratings due to low greenhouse gas emissions despite questionable labor and misinformation policies (an example of environmental factors giving a company a high ESG score despite alleged poor performance on social factors.)[19] One proffered reason is that social risk factors and issues have been poorly defined so far.[20] Asset managers may be able to derive the greatest value from ratings providers that present “E,” “S,” and “G” scores (or present even more granular information on an issue-specific basis with the “E” and “S” categories) individually and transparently so that they can provide the best solutions for their clients’ specific needs.

Ultimately, however, the current polyphony of approaches is reflective of: (1) the wide range of information to consider regarding a company’s ESG profile; (2) the lack of consensus on how to assess that information; and (3) divergent views on what constitutes “good” and “beneficial” in the broader ESG market. Only by offering greater transparency regarding the inputs to their rankings and how those inputs are assessed and weighed, can ESG ratings providers offer consumers of that information a basis to make informed decisions as to how to effectively utilize the ratings.

Our takeaways include:

A. Ratings Divergence: In its response to the EU’s consultation on a renewed sustainable finance strategy, ESMA cited one study finding that ESG ratings are 60% correlated, compared to a 99% correlation for credit ratings from the top three credit rating agencies. The lack of standardized ESG disclosures or weighting of ESG factors coupled with the grouping (and subjective weighting) of all ESG issues drives this divergence, which in turn causes market participants to question the accuracy and comparability of ratings by any ESG provider. However, while no doubt helpful, increased ESG disclosure alone seems unlikely to alleviate all the challenges associated with using ESG ratings. One Harvard study found that increased ESG disclosures were correlated with greater ESG rating disagreement—“[b]y moving from the 25th to the 75th percentile in terms of ESG disclosure, firms saw the spread between their best and worst ESG scores widen by as much as 31 percent.”[21] Because each ESG ratings provider selects its own variables, measures each variable using its own method, and weighs each variable to add up to its score differently, transparency regarding methods and input will not lead to ratings convergence.[22] That, in turn, calsl into question the utility of any provider’s rating, which is intended as a short-hand, simple way to assess a particular company’s sustainability characteristics. It follows that the current state of play, where ratings are only truly meaningful if the consumer takes the time to dig into the rating provider’s approach, will persist until there is an industry or regulatory consensus regarding ESG rating methodology.[23]

B. Tension Between the E, the S, and the G Calls for Distinct Scores for Each: As illustrated by the ESG ratings of Tesla, a company may have a positive environmental impact but a poor work culture. Though investors may care about both when reviewing a company’s ESG score, a poor “S” rating may obscure a positive “E” rating in an overall ESG rating and, thus, mislead investors or at least deprive them of valuable information regarding a company’s sustainability efforts. To resolve this issue, ESG ratings providers should consider assigning subscores for the “E,” “S,” and “G,” or even to discrete issues within each category.

C. Investors Should Not Rely on ESG Ratings as a Sole Indicator: As many asset managers already do, investors should look to ESG ratings—from multiple providers—as a starting point to guide further diligence. The divergence in ratings and variability in definitions renders ESG ratings unreliable as a sole mechanism to judge potential ESG investments.

D. Potential Litigation: Because ESG ratings can vary significantly, enforcement actions or litigation are possible. An asset manager that relies on a particular ESG provider to assess the sustainability of its portfolio may be accused by regulators or clients of “greenwashing” to the extent that other providers assign lower ratings to those same companies. Likewise, a company’s employees who participate in company-sponsored retirement vehicles could claim that the employer misrepresented the sustainability of investment offerings based on the divergence among ESG rating providers.

E. Conflicts of Interest: Another area of concern to regulators and other market participants is that ESG ratings providers often provide other services, such as ESG consulting services. The risk that a ratings provider might provide a better rating in order to win other business from a particular company raises a number of challenges, including the quality of disclosure regarding the issue, how a company or asset manager should deal with the potential conflict if it utilizes that provider’s ratings, and the concern that such conflicts may lead to industry regulation.

F. Ratings Bias: Consumers of ESG ratings should consider the possibility of unintended ratings bias being injected into the process. As noted above, RepRisk attempts to account for a large company bias, which it characterizes as negatively affecting large cap companies because they receive greater media attention. However, ESMA has pointed to a bias in favor of large caps, which have the resources to respond to provider surveys and generally address ESG perceptions in the marketplace. And, in fact, large cap companies on average receive higher ESG ratings.[24] Another potential bias, for example, could be based on geography—European companies on average score higher than U.S. companies, while companies in emerging markets generally receive lower scores.[25]

Link to the full Memo can be found here.


1Margaret Dorn, The (Re)Balancing Act of the S&P 500 ESG Index, S&P Dow Jones Indices: Indexology Blog (May 17, 2022), (go back)

2Is Tesla ESG? Many funds own it. We say it’s not for everyone, Bloomberg Professional Services: Bloomberg Intelligence (May 26, 2022),  For example, Tesla continued to be rated and ranked by Sustainalytics, a sustainability data and analytics firm owned by Morningstar, and also by Morgan Stanley’s unit Calvert Research and Management, where it remains included in various Calvert indexes.  See Leslie Norton, This is Why Tesla’s ESG Rating Isn’t Great, Morningstar (May 22, 2022), (go back)

3See, e.g., Lauren Foster, Tesla Got Dumped From an ESG Index. One Critic Calls the Move ‘A True Indictment’ of Sustainability Ratings, Barron’s (May 20, 2022),;, Tesla Is Being Booted From The ESG Index, Forbes (May 20, 2022),; Tim Quinson, Tesla’s Removal From S&P Index Sparks Debate About ESG Ratings, Bloomberg (May 19, 2022),; Eloise Barry, Why Tesla CEO Elon Musk Is Calling ESG a ‘Scam’, TIME (May 25, 2022),; Leslie Norton, This is Why Tesla’s ESG Rating Isn’t Great, Morningstar (May 22, 2022),; Tom Lyon, How Can a Sustainability Index Keep Exxon but Drop Tesla? A Look at ESG Ratings, The Fashion L. (June 15, 2022),; Cam Simpson, Akshat Rathi & Saijel Kishan, The ESG Mirage, Bloomberg (Dec. 10, 2021), (go back)

4 Anthony Kirby, Why data remains the biggest ESG investing challenge for asset managers, EY (July 5, 2021), (go back)

5Kevin Prall, ESG Ratings: Navigating Through the Haze, CFA Institute (Aug. 10, 2021), (go back)

6Garnet Roach, More than half of top 50 asset managers developing internal ESG ratings, IR Magazine (Mar. 8, 2021), (go back)

7Id. (go back)

8Simpson, Rathi & Kishan, supra note 3. (go back)

9Id. (go back)

10 Adeline Diab & Gina Martin Adams, ESG assets may hit $53 trillion by 2025, a third of global AUM, Bloomberg: Bloomberg Intelligence (Feb. 23, 2021), (go back)

11Jessica Ground, ESG Global Study 2022, Harv. L. Sch. F. On Corp. Governance (June 17, 2022), (go back)

12Emma Boyde, ESG ETFs face perfect storm in the US, Fin. Times (Sep. 13, 2022), (go back)

13Press Release, U.S. Securities and Exchange Commission, SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors (Mar. 21, 2022), also Jason Halper et al., SEC Proposes Climate-Related Changes to Regulation S-K and Regulation S-X, Cadwalader, Wickersham & Taft LLP (Mar. 23, 2022),; Jason Halper et al., What Can Public Companies Do Now to Prepare for the SEC’s New Proposed Rules on Climate-Related Disclosures?, Cadwalader, Wickersham & Taft LLP (Apr. 7, 2022), (go back)

14Press Release, European Securities and Markets Authority, ESMA Publishes Results of Its Call for Evidence on ESG Ratings (June 27, 2022), (go back)

15FS22/4: ESG integration in UK capital markets: Feedback to CP21/18, Fin. Conduct Authority 13 (June 2022), [hereinafter Feedback Statement, FCA]. (go back)

16Press Release, International Organization of Securities Commissions, IOSCO calls for oversight of ESG Ratings and Data Product Providers (Nov. 23, 2021), (go back)

17International Sustainability Standards Board, IFRS, (last visited Sept. 28, 2022); see also Simon Brooke, New International Sustainability Standards Board Aims to Unify ESG Metrics, Impactivate (Mar. 10, 2022), (go back)

18Florian Berg, Julian F. Kölbel, & Roberto Rigobon, Aggregate Confusion: The Divergence of ESG Ratings, 1 Rev. of Finance 4, 26-27 (May 23, 2022) (corrected proof), (using the term “noise” to describe divergent ratings); see also Tracy Mayor, Why ESG ratings vary so widely (and what you can do about it), MIT Sloan Sch. Mgmt. (Aug. 26, 2019),; Dane Christensen, George Serafeim, & Anywhere Sikochi, Why is Corporate Virtue in the Eye of The Beholder? The Case of ESG Ratings, (Harv. Bus. Sch., Working Paper No. 20-084, 2021),; Kristen Senz, What Does an ESG Score Really Say About a Company?, Harv. Bus. Sch. Working Knowledge (July 21, 2021), (go back)

19Hans Taparia, The World May Be Better Off Without ESG Investing, Stan. Social Innovation Rev. (July 14, 2021), (go back)

20Michael Posner, ESG Investing Needs More Rigorous Standards To Evaluate Corporate Conduct, Forbes (Feb. 1, 2022),; Jason Saul, Fixing the S in ESG, Stan. Social Innovation Rev. (Feb. 22, 2022), (go back)

21Kristen Senz, What Does an ESG Score Really Say About a Company?, Harv. Bus. Sch. Working Knowledge (July 21, 2021), (go back)

22Berg, Kölbel, & Rigobon, supra note 18. (go back)

23Abraham Lioui, Sustainable Investing with ESG Rating Uncertainty, Harv. L. Sch. F. On Corp. Governance (July 5, 2022), (go back)

24Osman T. Akgun, Thomas J. Mudge III, & Blaine Townsend, How Company Size Bias in ESG Score Impacts the Small Cap Investor, 1 J. Impact & ESG Investing 1, 4,  (2021), (go back)

25Garnet Roach, Inside the world of ESG ratings: Academic paper looks at multiple issues with process and outcomes, IR Mag. (Aug. 11, 2022), also David F. Larcker, Lukasz Pomorski, Brian Tayan, & Edward M. Watts, ESG Ratings: A Compass Without Directions 5–6 (Rock Ctr. for Corp. Governance Stan. Univ., Working Paper Forthcoming, 2022), (go back)

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