Bloomberg published an interesting piece last week on Adani, ESG ratings and claims of fraud. If you haven’t been following this saga, I wrote about it at the end of January, along with some background of Hindenburg – the research firm making claims of fraud against Adani. You might recall that Hindenburg also exposed the fraud of EV company Nikola.
Adani’s shares are – er, perhaps were – widely held in ESG funds:
“Stocks bearing the Adani name appear in more than 500 so-called Article 8 funds that are supposed to ‘promote’ environmental, social and governance goals under European Union rules, data compiled by Bloomberg show. About 80 of those exposures are via direct holdings, while the rest are mainly through funds of funds or index trackers, according to the data, which correct for duplicate holdings.
As Adani entities get stripped from indexes and are placed under review amid allegations of fraud and market manipulation, ESG investors are once again left wondering why a strategy intended to shield against risks such as greenwashing and bad governance — often at an extra fee — didn’t protect them from the latest meltdown.”
Readers know I advocate ESG data validation and due diligence because the overwhelming majority of raw ESG data used by ratings is fundamentally self-reported by the operating companies themselves. But one problem is that time and time again, we see that sophisticated fraud still occurs, confounding ESG ratings:
“Patrick Wood Uribe, the CEO of Util, an ESG research firm backed by private equity and venture capital investors, said the Adani debacle exposes some fundamental flaws in the approach adopted by several ESG index and ratings providers, as well as portfolio managers. ‘There can be a very large mismatch with what investors are expecting,’ when they place their money in a company or a fund classified as ESG, Wood Uribe said in an interview. And by offering an ‘overly simplified view,’ ESG ratings end up doing a ‘disservice’ to investors, he said.”
To be fair, fraud isn’t the only wrench in the works for ESG ratings. For instance:
“A little under a year ago, ESG portfolio managers scrambled to escape their exposure to Russian assets as Vladimir Putin’s invasion of Ukraine triggered sanctions and a global selloff of stocks and bonds tied to his regime.
Back then, it emerged that ESG funds were exposed to everything from Russian state-backed oil and gas companies to bonds issued by the Kremlin. The episode was treated as a moment of reckoning for the ESG industry that some of its earliest proponents said should force a rethink of methodologies clearly not fit for purpose.”
What This Means
In my view, there are a few layers to this onion.
- I expect we’ll see more companies with positive ESG ratings get exposed for fraud. It is simply a fact of life that highly motivated and sophisticated fraudsters can still get away with it – sometimes for a very long time.
- ESG ratings are simply not perfect, and users of the ratings need to understand that.
- Companies should make their best efforts to internally and externally validate efficacy of their ESG policies, procedures and implementation. Especially implementation.
- It would be wise to develop a contingency plan for how to respond to fraud, claims of fraud and other unexpected ESG events like the Russian invasion of Ukraine. This applies to operating companies, ESG investors with direct holdings, ESG ratings organizations and investors holding index funds.