Opinion: Amazon is proof of a serious weak point in ESG rankings

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If you own stocks, chances are you’ve heard the term ESG. It stands for environmental, social, and governance, and it’s a way to praise business leaders who take sustainability – including climate change – and social responsibility seriously, and punish those who don’t.

These investments have gained momentum in part because they meet investors’ growing desire to have a positive impact on society. By quantifying a company’s actions and results on environmental, social, and governance issues, ESG actions enable investors to make informed trading decisions.

However, investor confidence in ESG funds can be out of place. As scientists in the field of supply chain management and sustainable operations, we see a big flaw in how rating agencies like Bloomberg, MSCI and Sustainalytics measure companies’ ESG risk: the performance of their supply chains.

The problem with ignoring supply chains

Almost every business is supported by a global supply chain made up of people, information and resources. In order to accurately measure a company’s ESG risks, its end-to-end supply chain operations must be considered.

Our most recent research into ESG policies shows that most ESG rating firms do not measure companies’ ESG performance from the perspective of the global supply chains that support their businesses.

For example, Bloomberg’s ESG measure lists “Supply Chain” as a point under the “S” pillar (social). This measure treats supply chains separately from other items such as CO2 emissions, the effects of climate change, pollutants and human rights. This means that all of these elements, if not captured in the ambiguous supply chain metric, will reflect each company’s own actions, but not those of its supply chain partners.

Even when companies survey the performance of their suppliers, “selective reporting” can arise because there is no uniform reporting standard. A recent study found that companies tend to report green suppliers and cover up “bad” suppliers, effectively “greening” their supply chain.

Carbon emissions are another example. Many companies, like Timberland, have had great successes in reducing emissions from their own operations. Still, emissions from their supply chain partners and customers known as “Scope 3 emissions” can remain high. ESG rating companies were unable to adequately consider Scope 3 emissions due to a lack of data: only 19% of companies in the manufacturing sector and 22% in the service sector disclose this data.

More generally, without considering a company’s entire supply chain, ESG measures do not reflect the global supply chain networks that large and small businesses rely on for their day-to-day operations today.

Amazon and the third party problem

Amazon AMZN, + 2.50%,
is one of the largest and most popular positions in ESG funds. As a company bigger than Walmart WMT with + 0.35% annual sales, Amazon has reported emissions from shipping that are only one-seventh of Walmart’s. However, when researchers from two stakeholders checked public data on imports, they found that only about 15% of ocean shipments could be tracked by Amazon.

Additionally, Amazon’s number doesn’t reflect emissions from its many third-party sellers and their suppliers that operate outside of the US – its revenue comes from third-party sellers, approximately 40% of which sell direct from China, making emissions tracking and reporting even more difficult.

Another important ESG metric is consumer protection. Amazon prides itself on being “the most customer-centric company in the world”. However, when its customers have been harmed by products sold by third parties on its platform, Amazon has argued that it should not be held liable for the damage as it acts as an “online marketplace” that brings buyers and sellers together. Amazon’s overseas third-party vendors are often not subject to US jurisdiction and therefore cannot be held responsible.

Still, large ESG rating firms do not appear to reflect the supply chain impact on customer protection when measuring Amazon supply chain performance.

For example, in 2020, MSCI, the largest ESG rating firm, upgraded Amazon’s ESG rating from BB to BBB, reflecting its strength in areas like corporate governance and data security despite its consumer liability risk.

These gaps are also in ratings of companies like 3M MMM, -0.12%,
ExxonMobil XOM, + 0.99% and Tesla TSLA, -11.99%.

Other countries are increasing the pressure

There is currently no single reporting standard, so different companies can select specific ESG performance metrics to report in order to improve their sustainability and social ratings.

To improve consistency, the next step for ESG rating agencies would be to redesign their methodology to account for environmentally harmful and unethical operations across the global supply chain. ESG rating firms could, for example, create incentives for companies to record and disclose the activities of their supply chain partners, such as Scope 3 emissions.

In June 2021, the German Bundestag passed the law on due diligence in the supply chain, which will come into force in 2023. With this new law, large companies based in Germany will be responsible for social and ecological issues that arise from their global supply chain networks.

This includes bans on child and forced labor as well as compliance with occupational health and safety in the entire supply chain. Anyone who violates the law can expect a fine of up to 2% of their annual turnover.

The new Sustainable Finance Disclosure Regulation of the European Union, which came into force in March 2021, increases the pressure in other ways. It requires funds to report details on how they incorporate ESG characteristics into their investment decisions. That has led some asset managers to remove the term “ESG integrated” from some of their assets, Bloomberg reported.

Without similar laws in the US, we believe ESG rating firms could fill an important loophole. Of course, it is far more complex to examine a company’s ESG performance across the entire supply chain. However, by tying all of the ESG dimensions to a company’s end-to-end operations in the supply chain, rating firms can lead business leaders to be accountable for actions in their supply chains that would otherwise be kept in the dark.

Tinglong Dai is Professor of Operations Management & Business Analytics at the Carey Business School at Johns Hopkins University in Baltimore. Christopher S. Tang is Professor of Supply Chain Management at the University of California, Los Angeles. This was first published by The Conversation – “Investors who trust ESG funds for positive impact have a critical blind spot and it challenges the promises of the $ 35 trillion industry”.

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