TODAY’S STUDY: Making Green Investing Greener

ESG 2.0 – How to Improve ESG Scoring to Better Reflect Renewable Energy Use and Investment

September 2019 (American Council on Renewable Energy)

Executive Summary

The American Council on Renewable Energy (ACORE) is working with investors and other stakeholders to better reflect renewable energy use and investment in environmental, social and governance (ESG) rating methodologies. This white paper offers our views on the current state of ESG investing and provides recommendations for how ESG methodologies can be improved to better drive growth in renewable energy investment and deployment.

To help mitigate long-term climate change risks, utilities, investors and corporations are adopting aggressive sustainability targets and considering ESG criteria to better evaluate the impact of their investments. The potential allocation of ESG funds to renewable energy investment presents an immense opportunity to enhance renewable sector growth.

However, despite demand for climate-resilient funds, new “sustainability” investments often do not directly result in greenhouse gas (GHG) emission reductions. This is because ESG scoring for measuring climate impact is impeded by a few key issues:

• The Marketplace is Too Fragmented. The growing network of ESG stakeholders has not adopted a standard framework for scoring, making it difficult for rated companies and investors to make “apples-to-apples” comparisons among ESG rating methodologies.

• Rating Methodologies Are Not Transparent. ESG rating agencies often do not disclose their methodologies, using “black-box” proprietary information to calculate scores, a practice which limits both corporations attempting to improve their scores as well as investors seeking transparent information.

• ESG Information Is Often Not Material. While investors look to ESG ratings for data that may affect companies’ financial and operational performance, many ESG methodologies contain inputs that are not material, hindering capital from flowing to the companies that most deserve it.

To better reflect renewable energy use and investment in ESG methodologies, ACORE recommends:

1. Enhancing Renewable Energy Disclosure in Scope 1-3 Emissions. The extent to which companies drive additionality through their methods of renewable energy procurement, i.e., whether they add new renewable generation to the grid, should be more accurately captured in companies’ Scope 1-3 emissions reporting for their ESG scores. (See pages 14-15 for definition of Scope 1-3 emissions.)

2. Providing Credit for Avoided Emissions. Capital providers should receive credit for avoided GHG emissions attributable to their investment decisions.

3. Implementing Standardized, Material and Forward-Looking Data Reporting. To provide meaningful comparisons, ESG scoring should increasingly rely on widely agreed upon data inputs. In order to be impactful, ESG scoring based on that widely agreed upon data should include forward-looking analysis capable of holding rated companies accountable for progress over time.

4. Adopting a Universal Climate Benchmark. ESG scoring should help accelerate the transition to a decarbonized economy. International initiatives like the Paris Climate Agreement and U.N. Sustainable Development Goals can provide a common global benchmark against which companies’ ESG performance can be judged.

If utilities, corporations, investors and states intend to achieve the dramatic declines in GHG emissions scientists say are needed by 2050, the business community must move to adopt a standardized, transparent and forwardlooking approach that more accurately measures the climate impact of ESG investments.

Background

Renewable energy stands at the heart of efforts to address climate change, as scientists suggest that renewables will need to supply more than 70 percent of global electricity to li*mit planetary warming to 1.5oC by 2050.1 Investment levels are an important consideration as trillions of dollars in new electricity sector investment will be needed to meet the global targets in the Paris Climate Agreement.2

While these are aggressive targets, they pale when contrasted with the magnitude of climate change effects which are already taking a toll throughout the U.S. economy. In 2017, Goldman Sachs downgraded its GDP forecast by 0.8 percent due to three Category 4 hurricanes which exceeded $265 billion in damages.3As of April 2019, the grain belt had experienced its wettest 12 months ever, with repeated flooding and 200 more tornadoes than average, suppressing agricultural output.4

Meanwhile, U.S. sustainable investing has grown from $8.7 trillion in 2016 to over $12 trillion today, representing approximately one in four dollars in total U.S. assets under management.5 ESG investing, a sub-category of sustainable investing, evaluates companies’ environmental, social and governance practices along with financial factors. ESG has tremendous potential for climate change mitigation because it links companies’ climate impact with long-term financial performance.

Unfortunately, the subjective nature of ESG scoring does not always acknowledge companies who are leading the transition to a low-carbon economy. Absent recognition of a company’s downstream business activities, all else equal, there is a risk that a company that invests in or develops coal power plants could be rated the same as, or higher than, a peer company that invests in renewable energy or other technologies that mitigate climate change. This represents a fundamental shortcoming in the current rating system.

Key Recommendations

Enhance Renewable Energy Disclosure in Scope 1-3 Emissions…

Provide Credit for Avoided Emissions…

Implement Standardized, Material and Forward-Looking Data Reporting…

Adopt a Universal Climate Benchmark…

Conclusion

The analysis and recommendations in this paper aim to drive ESG investment toward the companies doing the most to mitigate the long-term damages of climate change. A full accounting of renewable energy use and investment in ESG scoring will go a long way toward achieving this objective. ACORE applauds the efforts of the ESG community and, with our vast network of investors and renewable energy companies, stands ready to collaborate with stakeholders across all relevant sectors to help implement these recommendations with the goal of realizing the full potential of ESG investing.

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