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Morningstar Affirms Integrity of ESG Research and Ratings

 
March 16, 2021

 

Morningstar built its business on a foundation of independent, objective research designed to democratize investment insights previously reserved for professional investors. More than thirty five years later, we don’t take for granted the trust we have earned from investors, and our research teams go to great lengths to apply the same rigor in producing insights across all investment areas and asset classes.

We will always be open to criticism that can make our research better for investors. Whenever the integrity of our research is questioned, Morningstar engages to understand the concerns; reviews the relevant data and research against the standards we maintain to ensure quality and objectivity; and transparently shares our findings so investors can decide for themselves. 

So, when suggestions of anti-Israeli bias in parts of Sustainalytics’ research emerged, we took those seriously. The research leaders of both Morningstar and Sustainalytics attempted to constructively engage with JLens, the group that levied the allegations, in a call on January 13, 2021. JLens ended the dialogue that was underway and has not responded to our repeated and most recent January 24, 2021 request for the specifics in our research that drove their conclusions. We remain willing to constructively reengage when they do.

Nonetheless, Morningstar’s executive leadership began an internal review of the research and product areas referenced. While we will always find opportunities to improve our work, our review found no systematic bias and concluded that the claims are false. In the interest of transparency, we are publishing the findings of our review, including background on how the referenced research services work and how investors use them.

Investors Have a Right to Know
Assessing the potential material risks ESG issues can have on a company’s long-term value is complex, but Morningstar believes investors of all kinds have a right to know about the risks associated with investments so they can make the financial decisions that are best for them.

Within Sustainalytics’ ESG Risk Rating, there are hundreds of E, S and G variables – some more impactful than others – that can expose a company’s unmanaged ESG risk, which can lead to a loss of shareholder value. In fact, our research methodology considers up to 270 variables, applied across 13,000 companies globally. ESG issues related to human rights, labor practices, business ethics, product quality, health and safety, data privacy, and environmental standards are not bound by geographical borders. Our research teams apply the same research methodology, process, and rating framework to all companies our analysts cover worldwide.  

Investors Need More Than One Vantage Point for Risk
Sustainalytics offers the following services to investors to address varying investor needs and considerations for company-level risk across material ESG issues:

ESG Risk Research Human Rights Research
Carbon Risk Research Sustainable Products Research
Country Risk Research Product Involment Research
Corporate Governace Research Weapons Research
Impact Research Controversies Research
Material Risk Engagement Global Standards Screening
Thematic Engagement Global Standards Engagement

Sustainalytics’ ESG research covers standard global universes, with the largest spanning 22,000 companies. Our analysts take a consistent research approach, assessing all companies the same way, regardless of location.

Several of Sustainalytics' research areas evaluate companies’ alignment to international norms, which includes international human rights law and international humanitarian law. While there are often shortcomings for any standard setter, particularly when looking across a global landscape, our research assesses companies within a framework according to industry-accepted standards, such as those set by the UN Global Compact (UNGC), UN Guiding Principles on Business and Human Rights, and the OECD MNE Guidelines for Multinational Enterprises, to enable consistent research. These organizations are not stand-alone sources for understanding the facts on the ground to independently analyze each company. Sustainalytics analysts always corroborate sources, and a resolution citing violations of norms of international law does not result in an assessment change without further analysis.

ESG Risk Research
Sustainalytics’ ESG Research and Ratings provide a consistent and coherent approach to assessing financially material risk resulting from a company’s exposure to and management of ESG issues. The qualitative research supports a quantitative ratings framework that categorizes a company’s unmanaged ESG risk from negligible to severe. The research process and the ratings framework follow consistent methodologies across standard universes of companies. You can learn more about Sustainalytics ESG Risk Research and Ratings, including the methodology, here.

Controversy Research
Sustainalytics’ controversy assessments evaluate a firm’s involvement in negative incidents across primary ESG topics that include (but are not limited to) human rights, labor practices, business ethics, product quality, health and safety, data privacy, and environmental standards.  Our analysts perform daily monitoring of 60,000 news sources from around the world to identify incidents that could be significant from an ESG perspective (e.g., mining collapses, oil spills, ethics probes, labor abuses, etc.). 

Based on this monitoring, our analysts identify incidents and collect relevant information and references. Individual incidents accumulate and escalate into controversies. Controversies are classified into 10 topical areas and scored on a scale from one to five, based on the negative impact incidents have caused to the environment and/or society, the business risk to the company as a result of these incidents, the company’s response to these incidents, and the strength of the company’s management systems to prevent a recurrence. The severity and frequency of incidents, accountability of the company, exceptionality within the industry, impact created, and reputational exposure are all considered. This research is applied across approximately 13,000 companies and is an input to Sustainalytics’ ESG Risk Rating.

Of the 21,000 rated controversies in our research, only 103 controversies are related in some way to operations in the conflict areas in Israel. It is not uncommon to see controversies in conflict zones, where complicity in human rights impacts are challenging to manage. For example, Sustainalytics analysts have found several high-level conflict-related controversies in Western Sahara, Myanmar, Sudan, etc.

Simply operating in a conflict zone does not merit a controversy rating—it is only applied in cases where controversial incidents are deemed to have a negative impact and create reputational, operational, and business risk for the company. 

Of the 103 controversies that relate exclusively to operations in Israel, two rise to a category four—generally the starting point for serious concerns by Sustainalytics clients. None reached a category five. This proportion of category four controversies is in line with global distributions. 

The two current category four controversies apply to two companies:  

  • Israeli-based international defense electronics company Elbit provides equipment to the Israeli military, believed to be specifically tailored for the security wall that separates Israel from the Palestinian Territories. This includes security cameras and unmanned aerial drones. The International Court of Justice has ruled the separation wall as illegal, and human rights NGOs have criticized it as directly contributing to a range of human rights violations.
  • U.S.-based Caterpillar Inc. faces strong criticism regarding its alleged involvement in human rights violations in disputed territories. This stems primarily from numerous allegations that for three decades the company has been selling its D-9 bulldozers to military authorities in Israel that are being used to support settlements in the conflict area. This reflects an indirect involvement in human rights impacts in the conflict. The extensive media coverage and considerable public criticism over the company’s human rights violations in the conflict area makes the company vulnerable to reputational damage.

In some cases, these companies also have controversies in other parts of the world, and they are not unlike the risks Sustainalytics analysts attribute to other companies, for example Volvo for its operations in Myanmar and Egypt, or to Lockheed Martin for the use of its weapons in Yemen.

Global Standards Screening and Engagement Services
In cases where companies’ activities severely and systematically violate global standards such as the Principles of the UN Global Compact and the OECD Guidelines for Multinational Enterprises, Sustainalytics Global Standards Engagement Services attempts to engage in constructive dialogue with the company on behalf of institutional investors to affect change. These cases are identified through our norms-based screening capability called Global Standards Screening (GSS), which screens approximately 30,000 companies globally across all sectors. Screening identifies companies in significant violation of these international norms. GSS clients typically screen a portion of these companies out of their investable universe.  These companies are also added to our Global Standards Engagement list.

Currently, of the approximately 354 companies with GSS status as “Watchlist” or “Non-Compliant”, there are three companies—Elbit Systems, Ashot Ashot Ashkelon Industries Ltd. (subsidiary of Elbit), and Motorola—whose status relates to activities in the conflict area in Israel. Another 22 companies have a Watchlist or Non-Complaint status due to their activities in other conflict-affected countries such as Western Sahara, Sudan, Myanmar, and Kurdistan.  

Again here, operating in a conflict-affected area alone does not warrant Watchlist or Non-Compliant status. As with every other part of the world, it depends on the company’s involvement in or linkage to human rights abuses or other egregious breaches of global standards, as determined by international human rights law.   

Examples of corporate activities in conflict-affected regions that might trigger Watchlist or Non-Compliant status in GSS include:

  • The supply of surveillance and identification equipment to monitor settlements at the wall and checkpoints directly linked to those settlements. 
  • The supply of equipment for the demolition of housing and property, the destruction of agricultural farms, greenhouses, olive groves, and crops. 
  • Infrastructure projects of exceptional scale that negatively impact civilian populations.

Human Rights Research (Human Rights Radar)
Sustainalytics Human Rights Radar explicitly identifies companies at risk of being complicit in human rights violations because they are operating in conflict-affected countries and territories where there is a high risk of human rights violations taking place. Sustainalytics does not take a stance on the political situation in these countries and territories, rather, the research considers that companies operating in conflict-affected contexts face complex challenges in respecting human rights and therefore run a heightened risk of violating human rights or of being complicit in human rights violations.  

Human Rights Radar evaluates companies’ involvement in conflict-affected countries and territories by looking at their industry, business activities, and if relevant their degree of involvement in the conflict.  

The research reflects on the number of high-risk countries a company is involved in and assesses the companies’ preparedness to prevent and mitigate adverse human rights impacts. Our analysts leverage the United Nations’ Guiding Principles on Business and Human Rights as our assessment framework.

Research coverage includes Central African Republic, Equatorial Guinea, Eritrea, Libya, North Korea, Saudi Arabia, Somalia, South Sudan, Sudan, Syria, Turkmenistan and Uzbekistan, Palestine, Western Sahara and Tibet. The countries and territories are selected based on which have the lowest aggregated score for political and civil rights, according to the non-governmental organization Freedom House. 

Morningstar Affirms Our Independence
Morningstar and Sustainalytics strive to deliver the highest quality, most insightful research possible to empower investors of all types.  

In the face of serious allegations, our internal review confirmed Sustainalytics’ research processes and methodologies are applied consistently across every company in its global universe, regardless of where it is domiciled or conducts its business. Each of our methodologies across a wide spectrum of the investment landscape is designed for objectivity and subject to rigorous testing and review by governing committees to ensure they are free from bias. Finally, Sustainalytics’ engagement activities are efforts by our team on behalf of investors and for the benefit of companies and society as whole.

Neither Morningstar nor Sustainalytics supports the anti-Israel BDS (Boycott, Divestment, Sanction) campaign, nor do our research teams have specific policies for or apply different standards to Israeli companies. Our research teams do not maintain so-called blacklists, and Sustainalytics does not encourage or recommend divestment of companies on the basis of their connection to Israel in any way.  

While human rights are the bedrock of society, we embrace independence and transparency as the bedrocks of our research.    

ESG Risk Research and Ratings

Sustainalytics’ ESG Risk Ratings empower investors with a coherent and consistent approach to assessing financially material Environmental, Social and Governance (ESG) risk.

Understanding Human Rights as Material ESG Issues

Sustainalytics’ ESG Risk Ratings consider how companies manage the impacts and risks related to human rights issues. Our framework looks at two separate material ESG issues (MEIs): Human Rights, and Human Rights – Supply Chain.

Human Rights Radar

Sustainalytics’ Human Rights Radar helps investors identify and understand companies’ involvement in countries and territories where there is a high risk of human rights violations.