Multi-billion-dollar investment firm Morningstar announced it will discontinue using a product employed by its subsidiary, Sustainalytics, to rate a company’s commitment to corporate responsibility. The decision comes after an independent investigation deemed the product biased against Israel.
The product in question is Sustainalytics’ Human Rights Radar (HRR), one of the “environmental, social and governance” (ESG) rating systems marketed for investors who want to understand a company’s approach to a host of social issues, including sustainability, climate change, treatment of employees and impact on neighboring communities.
While Morningstar is to be commended for halting its use of HRR, the investigators’ findings raise bright red flags, not only about HRR but about other Sustainalytics products, and ESG in general.
The investigation undertaken by the law firm of White & Case concludes that HRR has a disproportionate focus on the Israeli-Palestinian conflict that resulted in “biased outcomes disfavoring companies doing business in Israel.” This comes as no surprise now that it is known that Sustainalytics developed the product in collaboration with an unidentified client having a particular interest in the Israeli-Palestinian conflict. The report also exposes the HRR team’s repeated use of inflammatory language to describe Israeli companies and its failure to attribute its findings to any source, as well as the fact that the team received zero oversight from Sustainalytics.
HRR is not the only problem, though. Take, for example, Sustainalytics’ ESG Risk Rating, described in the report as the company’s flagship product. The ESG Risk Rating, the report explains, “is designed to help investors identify and understand financially material ESG-related risks within their investment portfolios and how those risks may affect issuer performance.”
How does Sustainalytics evaluate risk? According to the White & Case report, Sustainalytics researchers start by flagging controversial events reported in the media by NGOs, the UN and even by advocacy campaigns, like those driven by anti-Israel Boycott, Divestment and Sanctions (BDS) groups, whose aim, according to one of the movement’s founders, is the elimination of Israel. “With respect to reputational risk,” the report tells us, “the assessment narrative that accompanies a controversy rating will make note of advocacy campaigns that have targeted a company in connection with a particular incident, or decisions by third parties to divest from the company in relation to that incident.”
"Media noise" and its effectiveness
IN OTHER words, Sustainalytics looks at media noise, reliable or not, in evaluating and rating companies. Given the volume of BDS campaigns and BDS-related material appearing in the media, Sustainalytics’ approach could easily result in ESG ratings influenced by parties with an anti-Israel agenda.
Sustainalytics has already eliminated a few obviously biased sources, such as the Iran Daily and Electronic Intifada, a notoriously anti-Semitic online platform that actively campaigns against Israel. But the company continues to maintain a particularly close relationship with WhoProfits, an NGO that leads a host of BDS efforts against Israeli companies. Several Sustainalytics platforms – not just HRR – rely on WhoProfits as a source in the context of research involving the Israeli-Palestinian conflict areas.
Israeli companies may also find themselves on Sustainalytics’ watch list if they are linked to alleged violations of human rights by groups like Human Rights Watch and Amnesty International, both of which have published much-criticized and roundly debunked reports accusing Israel of apartheid, twisting out of recognition the accepted international definition of that word.
Sustainalytics’ employees told White & Case investigators that the company’s ESG ratings are not meant to serve as a blacklist of companies clients must avoid investing in or must divest from. At the same time, employees acknowledged that some clients might use their ESG products in this manner – after all, that is the reason most investors use ESG ratings in the first place.
The report concludes with 43 recommendations and advises the company to reconsider its practice of pressuring Israeli companies in letters, co-signed by investors, advising them of the importance of cooperating with Sustainalytics. “The practice of drafting such statements on behalf of investors and sending to companies on investor letterhead” exceeds the bounds of objective analysis. It may also, as White & Case observes, “run afoul of the intent of certain anti-BDS legislation in the United States.”
It may be reasonable to let investors know that a company is being targeted by activist groups like BDS, but using the opinions of such groups to assess a company’s performance, legal status, or behavior raises series concerns about objectivity. ESG research companies should base risk assessments on verifiable facts and legal expertise, not biased reporting. Hopefully, regulation by the Securities and Exchange Commission (SEC), reportedly in the works, will help ensure that ESG ratings are objective, transparent and less likely to reflect the political agenda of groups like BDS.
Lerman is vice-chair of the Louis D. Brandeis Center for Human Rights Under Law, an NGO that conducts research, education and advocacy to combat the resurgence of anti-Semitism on college and university campuses.