ESG and the Scandal of Boohoo

August 10 2020 - ,

In July 2020 the UK-based apparel retailer Boohoo found itself in the middle of a scandal, concerning its use of what could effectively be called sweatshops. For experienced observers of global apparel retailers and their supply chain, this controversy would not be anything particularly new, used as they are to stories of abuses linked to garment factories in the near and far east. The only problem is that, in this case, the factories were not thousands of kilometres away, but in Leicester, UK, some 100 miles straight up the M1 from London.

At the same time, the ripple effects of the scandal hit a different sector of the economy: finance and, in particular, the ever-growing subsector of ESG investments. Just three weeks before the news broke, one major ESG data provider had given Boohoo one of its highest ratings, making it clear that it saw the company as being miles ahead of its competitors in its Environmental, Social and Governance credentials. 

So, what caused this issue, and how can researchers who are expert in the field have been so wrong? In our view, the problem lies in two places: the push towards more and more automation of the research process; and the fact that larger companies have better resources to provide information to satisfy such automated research processes. The request to provide quick and easy ratings on issues as complicated and difficult to identify as the weaknesses in a company's supply chain, coupled with the sheer number of stocks that each rating provider is asked to cover, means that the human aspect of the research process is more and more put to the side.

There is an expectation that the ratings from the different research houses should be the same but this does not reflect the reality of the situation on the ground. Tesla is a frequently quoted example - how can one research provider assign the company a high score, while for another the score is low? The answer is in the nature of the issues covered. ESG ratings are by their nature much more nuanced than purely financial-based ones, because they focus on both natural and human factors that, in many cases, cannot be standardised (I can already hear the sighs and gnawing of teeth from the accountants, so I'll straight away state that I don’t think that there is anything simple in financial analysis).

The second problem lies in the fact that smaller companies find it much more difficult to provide the information that the research houses want, leading to the perverse scenario where companies such as British American Tobacco often score better than the smaller businesses whose operations focus on curing cancer caused by cigarette smoke. 

We believe that what this all boils down to is the need for what we jokingly call HI - i.e. old-style human intelligence. Research needs to rely both on standardised KPIs, but also on proper leg work from the analysts, who must keep in contact with the company, engage with the workers along the supply chain and, most of all, never take for granted the companies' own reporting. This does not imply a distrust in company reporting, which is a fundamental element in the research process, but shows how important it is to go deeper, and to question when a company lacks transparency on how it is performing, even if it has all the "necessary" policies.

This is the view that drives Ethical Screening's research: while we do employ KPIs to provide standardisation and uniformity to our research approach so data are comparable, we go beyond. When the analysis brings results that we have concerns about, or when we can't find enough information, we go deeper, using the contacts that we have developed in over 20 years of ethical research. While we do employ a score, we have designed it in a way that reflects not only what the companies say about themselves, but also what they don't say, because we know that potential risks to our clients' reputations are always around the corner.

Lastly, we don't believe in providing clients with simple, one-dimensional scores. We believe that the narrative behind the numbers is as important as the numbers themselves, if not more. For this reason, we engage with our clients and invite them to raise queries and challenge us about our analysis, because we know that this is the only way to equip them with the tools to make really informed decisions.

The controversy around holding Boohoo is not the first time asset managers have been caught holding companies whose actual profile does not match the score that they have been given, and it is unlikely to be the last. This does not mean that ESG ratings are useless, but that both the gathering of information and its interpretation and use need to be smarter - less artificial and more human in fact. Our aim at Ethical Screening is to do our best to shield our clients from reputational risks, by providing them with comprehensive and nuanced information based on robust research processes.

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