ESG ratings and the Tesla case

Tesla, Inc. is a multinational company founded by renowned entrepreneur Elon Musk and specializing in the production of electric vehicles. Its mission is ‘to accelerate the world's transition to sustainable energy' and, therefore, the reduction of fossil-fuel dependency. In spite of its goal to combat climate change, on 19 May Tesla was removed from one of the main ESG market indices, the S&P 500 ESG Index, a basket of shares of the leading US companies with high sustainability ratings. As our loyal readers should know by now, sustainability is measured by ESG ratings, based on Environmental, Social and Governance factors.

Let's try to understand what happened. How is it possible that such an environment-oriented company can be considered not sustainable?

ESG stock indices are created and managed by private companies, which periodically review the lists of index components. In order to be included in an ESG benchmark, such as the S&P 500 ESG Index, a company must be assessed by a specialist ESG rating agency. The company's ESG score will reflect its sustainability in terms of corporate management and investment projects.

How are sustainability ratings calculated?

There are a number of aspects that are considered when assigning ESG ratings. Environmental stewardship is certainly important but is only one of the three pillars upon which the ESG rating is based. Indeed, rating providers also assess the impact of business operations on the whole society (e.g. working conditions and the respect for human rights along the value chain) and corporate governance (e.g. diversity policies and management independence).  Therefore, in practice, taking ESG factors into account in your investment decisions means directing capital, your own savings, towards companies and projects which, for instance, respect the environment, promote workers' inclusion and wellbeing, and encourage the appointment of women to the board of directors.

Important

Those who invest in sustainable financial instruments must be aware that the importance attached by rating agencies to the three sustainability pillars varies according to the issuer's sector. For financial companies, which typically have a low environmental impact, the social and governance components will weigh more, whereas environmental stewardship will be front and centre when assessing companies in some manufacturing sectors, such as hydrocarbon extraction, which typically have a high impact on the environment. This practice, which is widely used by the leading rating agencies, aims at rewarding a company's virtuous behaviour within its industry, regardless of the broader sector.

While there is consensus on the three ESG pillars, at the moment there are no shared rating methods at the international level. This means that different rating agencies may give the same company very diverse ESG scores that are difficult to compare.

What happened to Tesla, then?

Tesla scored low on ESG aspects related to the work environment, discrimination and the safety of automated driving systems, resulting in its removal from the S&P 500 ESG Index.

What is the lesson to be learned? ESG is not synonymous with 'environmental protection'

The Tesla case shows that the ESG acronym is not to be confused with environmentally friendly, as it reflects a wide-ranging assessment of a company's commitments on different fronts. However, you can invest with a focus on environmental protection and climate change through specific financial instruments, including green bonds and mutual funds that require compliance with the Paris Agreement's target of limiting global warming to 1.5° C compared to pre-industrial levels.

The financial market is full of ESG opportunities and financial advisors can help you choose the best investment solution for you!