By Chris Leahy – 百峰创始合伙人
Online fast fashion retailer, Boohoo Group PLC (BOOH.L), brought tears to the eyes of its shareholders after a Sunday Times investigation in July alleged that a subcontractor of the group was paying less than half of the UK minimum wage to its employees in a sweatshop in Leicester.
The share price tanked as institutional investors dumped the stock. From GBP 3.8750 just ahead of the Sunday Times’ article, the shares fell almost 46% in a few days, to a low of GBP 2.10, before recovering some of the lost ground in the weeks since. The longer-term impact on the company may be more painful than the dent to its market capitalization. Major retailers that carried the group’s fast fashion brands have canceled orders and refused to deal with the group until they are satisfied that Boohoo has got its house in order.
Among the investors that were burnt in the share price rout were several prominent ESG-focused investment funds, including, in a cruel irony, the Aberdeen Standard Investments’ UK Impact Employment Opportunities Equity Fund.
The company was quick to express outrage—as well as ignorance—of the Sunday Times allegations. The Boohoo board announced an independent review of its supply chain and a GBP 10 million commitment to eradicate supply chain malpractice.
It seems that the money may well be needed to fix Boohoo’s own supply chain. While denying the Sunday Times’ claims of modern-day slavery within its UK supply chain, the company was forced to admit that a subcontractor of a subcontractor, instead of manufacturing a contracted order in the UK, had in fact sourced products from Morocco and repackaged them as UK-manufactured to meet contractual requirements.
Along with tearful investors were red-faced ESG ratings agencies, in no small part responsible for Boohoo’s putative ESG credentials. Enormous demand for ethical investing from asset owners has driven the growth in ESG-focused funds: more than 3,000 asset owners, investment managers, and other firms have signed the UN Principles for Responsible Investment declaration, accounting for more than USD 100 trillion in assets under management and/or owned. Combined with the move toward passive investing and the growth of Exchange Traded Funds, demand has taken off for third-party ESG ratings to launch new funds or reorient existing strategies toward ethical investments.
No one expects demand to tail off. According to Research Affiliates, a research advisory firm focused on smart beta and asset allocation strategies for investment institutions, there are already some 70 providers of ESG data and ratings, including firms providing ESG scores or ratings used by institutions for portfolio construction.
Several of these ratings agencies issued glowing scores for Boohoo, which explains, at least in part, why so many ESG funds were invested. CSRHub, an aggregator of ESG ratings and other data sources, awarded Boohoo a CSR/ESG ranking of 70%, suggesting a significant outperformance among the almost 20,000 companies ranked.
Yet the NGO, Fashion Revolution’s Fashion Transparency Index, which independently ranks the 250 largest fashion brands and retailers based on their disclosure of social and environmental policies, practices, and impacts, ranked Boohoo in the bottom 10%, and scoreless on the issue of traceability, the very issue that tripped Boohoo up.
How did it all go so wrong? Part of the problem lies with the ratings agencies themselves. Measuring environmental, social, and governance issues isn’t as straightforward as judging whether a company is likely to default, which is what credit ratings agencies—which now own many of the ESG ratings providers—traditionally do. ESG issues are far more subjective and open to interpretation.
Agencies rely to a significant extent on data provided by individual companies to compile their scores. That can lead to selective disclosure by companies keen to tout puffed up ESG credentials, which are becoming increasingly important to access specific but significant pools of capital. It also tends to favor larger companies over smaller ones, which often lack the resources needed to manage the considerable data disclosure and reporting obligations necessitated by ratings.
The construction of ESG scores by the agencies themselves can be highly subjective and often leads to wide diversity in scores for the same companies by different agencies. A study by MIT Sloan School of Management in May 2020, entitled “Aggregate Confusion: the Divergence of ESG Ratings,” studied the ratings of six separate ESG ratings agencies and found an average correlation of just 0.54 across scoring of the same companies. The range in score correlations was also significant, between 0.38 and 0.71. The principal reasons for the differences, according to the study, relate to the specific attributes and metrics chosen by a ratings agency. Not all use the same factors to assess ESG risks, and no single ESG standard exists by which risks can be evenly measured. Weightings of factors employed by ratings agencies also vary, which can skew scores. The report also noted what it termed an inherent ratings bias, where scores for a single company were consistently and similarly scored regardless of the specific ESG risk being assessed.
If that sounds too theoretical, another study by Research Affiliates constructed portfolios of stocks for both the United States and Europe using ESG ratings from two unnamed leading agencies. Over the eight-year period of simulation, the portfolios produced vastly differing cumulative returns. The simulations varied by 10% in the European portfolio and 24.1% in the US portfolio, despite an identical portfolio construction strategy.
Not all the blame should be laid at the feet of the agencies. Any asset manager who slavishly (or lazily) follows chosen ratings scores to screen or construct their ESG portfolio is also at fault. ESG ratings are inherently backward-looking and subjective. They are opinions, like buy/hold/sell recommendations from sell side investment bank research.
Could the Boohoo debacle have been avoided? Yes, with independent, arm’s length, in-depth research. Reporting—and the ratings industry that relies on it for its assessments—is just one (skewed) data point. What is really needed are facts: independently sourced, incontrovertible facts.
Blackpeak is a global leader in ESG investigations, and committed to ascertaining what is actually happening at a manufacturing plant, a mine, in a boardroom, or deep within a supply chain, regardless of ratings, scores, or what the company tells investors. Blackpeak uses the Sustainability Accounting Standards Board’s risk matrix index and ethical investigative research methodologies to search, monitor, assess, and mitigate ESG risks for asset owners and managers.
Perhaps the real lesson of the Boohoo scandal is that, amid all the noise of ratings, artificial intelligence, and passive investing, it can be easy to lose sight of that rarest and most precious of human commodities—basic common sense.
After all, how ESG-friendly can fast fashion really be when it can manufacture, market, and sell a branded T-shirt in a city mall for the cost of a coffee at Starbucks? If it sounds too good to be true, then it probably is.
ESG at Blackpeak
Blackpeak, an Acuris company, is partnered with the Sustainability Accounting Standards Board (SASB) to employ a rigorous and scalable ESG framework that identifies ESG actual or potential issues within any corporate ecosystem. Blackpeak licenses and applies the SASB Materiality Map® General Issue Categories in our work.
SASB is the global leader in setting sustainability disclosure standards that are industry-specific and tied to the concept of materiality to investors. SASB believes that a shared understanding of companies’ sustainability performance enables companies and investors to make informed decisions that drive improved sustainability outcomes and thereby lead to improved long-term value creation.
In partnership with SASB, we now provide solutions across the investment cycle:
- Blackpeak Diligence: We conduct due diligence research to identify and assess specific ESG risks for institutional investors, private equity and private credit funds, banks, and investment banks.
- Blackpeak Screening: We conduct high-volume screening to ensure ESG regulatory and legal compliance for banks and investment banks, non-banking financial institutions, and multinational corporations.
- Blackpeak Research: We conduct ESG portfolio monitoring and assessment for institutional investors, governance campaigns for hedge funds, and activist investors.
- Blackpeak Investigations: We assist with incident response and conduct discreet investigations into key ESG issues, provide investigative support and advisory services for disputes, and monitor and assess supply chains for ESG risks for private equity portfolios and multinational corporations.