Environmental, Social, and Governance (ESG) factors have captured most people’s attention these days, not just because of existing regulatory frameworks but because of the changing priorities of retail, banks, and institutional investors.
Companies are doing their best to redesign their business models to cope with the fast-paced environment. Most of these companies have prioritized sustainable development, and they understand perfectly that future growth is difficult to accomplish without this.
ESG rating agencies evaluate a company’s vulnerability to long-term Environmental, Social, and Governance-related risks. Usually, these risks comprise issues like climate change, working and safety conditions, and board independence.
With the adverse effects of the COVID-19 pandemic, it’s been evident that business models that uphold ESG factors are less affected by regulatory and technological disruptions. As a result, businesses benefit from an increased competitive advantage in the long run.
What’s more, businesses that have implemented ESG aspects are usually more prepared for crisis management. Data obtained from ESG can help companies to better cope with setbacks, accelerate recovery, and push for innovations that help them function optimally in a new normal while reducing the risk of future crises.
These issues have financial implications for any company. But they are rarely highlighted in conventional financial reviews. These companies evaluate the ESG performance of companies and make ESG data accessible to their customers.
There are more than a few companies using ESG ratings. Here are a few of the top ones.
The Corporate Knights Global 100 is one company using ESG ratings to compare and rank companies against their peers.
It evaluates capital investments and share of revenues featured in the Corporate Knits Clean Taxonomy and uses percentages to rank ratios against a predetermined peer group. Equal weights are then offered to the ratios, and up to 42.5 points are awarded for clean revenue and a maximum of 7.5 points for companies with clean investments, making a total of 50 points.
According to the Corporate Knights’ ranking of the 100 most sustainable companies, their data indicates that companies embracing ESG perform better than their peers. Some of these companies include Vestas Wind Systems A/S, Autodesk Inc, Schneider Electric SE, American Water Works Company Inc, and Brambles Ltd.
Bloomberg ESG Data Service is also ranked among the best ESG data providers on the market. Their ESG data services provide ESG metrics and disclosure scores of over 14,000 companies in more than 100 countries.
Besides their wide data coverage, Bloomberg’s ESG dataset features historical data dating back to 2006. The provider’s data is well-organized into 2000+ fields covering many sustainability topics, including air quality materials & waste, compensation health & safety, climate change, diversity, shareholders’ rights, and more.
One of the main perks of using Bloomberg’s ESG data is that their analysts have standardized as-reported data to guarantee it covers 80% of a company’s operations. As a result, investors can make informed decisions about a company’s operational impact.
Clients can also take advantage of Bloomberg’s daily updated content and the wide coverage of ESG topics.
The DowJones Sustainability Index offers transparent, timely ESG data set that provides an in-depth overview of a company’s financial performance and strategy. Data is normally obtained from a news-driven model that takes into account news from Factiva’s global collection.
The DowJones index ESG range from broad-market ESG, climate, fixed income ESG, and thematic ESG. The company also offers customized custom ESG solutions to help clients address their specific objectives and gain a competitive edge ahead of emerging sustainability trends.
Sustainalytics Company ESG Reports evaluates a company’s exposure to ESG risks related to specific industries and how well companies mitigate those risks.
It’s through this multi-dimensional approach to measuring risks that Sustainanalytics achieves an absolute assessment of ESG risk. Sustainalytics classifies risks that can affect a company’s value into five categories: negligible, low, medium, high, and severe.
Sustainalytics covers over 16,000 companies globally and offers a rating framework supported by more than 20 material ESG issues.
MSCI ESG Research solutions help clients to better understand and examine key risk drivers. This helps them develop more confidence in using effective portfolios with the help of data-driven solutions and tools.
MSCI offers unique benefits to its clients with its diverse and rich reports. For instance, with integrated carbon risk assessments, their clients can understand how carbon risk management can affect their performance. Their reports also assess key sectors where risk is concentrated to ensure companies can adopt carbon reduction strategies in advance.
RepRisk’s ESG approach is somewhat different as it screens more than 100,000 public sources and key stakeholders in more than 20 languages. They obtain data from many sources, including print media, social media, online media, government bodies, newsletters, think tanks, regulators, and other online sources.
RepRisk strives to provide more than just ESG ratings; it identifies and evaluates material ESG risks. Its ESG approach is more of an outside-in approach since it analyzes data from public sources and excludes company self-disclosures. RepRisk works based on the assumption that self-reported data isn’t reliable, especially regarding company risks.
Thomson Reuters ESG Research looks at a company’s main ESG activities and provides an in-depth analysis of a company’s progress toward its goals. The ESG data provider has more than 400 ESG measures screened by their experts to ensure accurate and standardized information is delivered to clients.
The company’s ESG data is updated regularly and refreshed every two weeks, which involves recalculating ESG scores. In terms of coverage, Thomson Reuters ESG scores cover over 6,000 public companies globally.
When it comes down to the ratings of companies, ESG factors can determine how trillions of dollars are invested in a specific company.
But what exactly are ESG ratings? What’s the meaning behind these ratings? And who creates them?
Put simply, ESG ratings evaluate a company’s level of resilience with regard to Environmental, Social, and Governance risks. Commercial and non-profit organizations develop ESG ratings to evaluate how company commitments, structures, business models, and performance align with sustainability goals.
Here’s a quick look at the three dimensions of ESG:
According to the 2030 Agenda for Sustainable Development of the United Nations and the Paris Agreement on Climate, a business should strive toward energy efficiency. It should work toward reducing its carbon footprint and put efforts in place to reduce the wastage of natural resources.
The social dimension looks at the quality of the working environment. A business social environment should promote diversity and worker inclusion, irrespective of gender, age, or ability. This parameter also considers corporate social responsibility and worker safety from a global perspective.
Governance reflects on the company policy that pushes for the transparency of the board of directors. The governing board should have sustainability plans and objectives and conduct themselves ethically.
Who uses these ratings? Typically, ESG scores are used by investment firms to appraise companies in their respective funds and portfolios. Customers, job seekers, and other individuals can use these scores to gauge business relationships. The rated firms can also use ESG scores to understand their strengths, weaknesses, opportunities, and inherent risks.
ESG scores are calculated by ratings firms using a quantitative or qualitative approach. The former relies on public information a company issues in compliance with international standards.
On the other hand, a qualitative approach obtains ESG scores based on data collected through questionnaires and other external sources. Data is then assessed using different methods.
With the increased popularity of ESG ratings, several ESG calculators have been developed to help companies tally their ESG ratings. It’s vital to settle for the best ESG calculation engine to comply with the rapidly changing requirements and regulations.
Corporate Social Responsibility (CSR) is gradually morphing into environmental, social, and governance (ESG) for most companies. Due to this transformation, there’s growing evidence indicating that ESG has a positive impact on an organization’s financial performance and business strategy in the long run. Good ESG scores attract investors and help with the retention of diverse talent.
Here’s a closer look at the impacts of ESG:
ESG investing is also termed “socially responsible investing,” “sustainable investing,” or “impact investing.” Typically, this form of investment prioritizes ESG factor outcomes, including optimal environment, social, and governance.
ESG investing is perceived as a move toward investing “sustainably.” In other words, priority is placed on investments that consider the environment, the economy, and human well-being. It’s also worth noting that ESG investing is based on the notion that social and environmental factors often affect the organization’s financial performance.
ESG can also impact stock prices. We all know the drill. When an organization is caught disregarding consumer safety or polluting the environment, the media is all over it. Shortly after, the company’s stock prices fall significantly. This proves that investors are more aware of environmental, social, and governance (ESG) issues.
Therefore, there’s a good chance they might invest more resources when there are positive developments.
Awareness of the inherent risks of climate change has increased significantly. As a result, organizations are also doing their best to focus on sustainability and ESG. The ESG approach ensures this transformation happens.
Focusing more on the ESG factors helps to move closer toward net-zero carbon emissions. These factors include financial performance, greenhouse gas emissions, societal impact, and capital investment.
ESG criteria integration has helped push for strategies supporting the transition into sustainable investments. It’s worth noting that ESG investing, sustainable investing, and socially responsible investing are similar concepts that emphasize using personal values and beliefs to make better investment decisions. However, these concepts have varying goals.
Socially responsible investing strategies largely depend on ESG scores to determine whether to invest in companies or not. While not all companies perform exceptionally well in environmental, social, and governance factors, ESG ratings are helpful over time since they are continuously reviewed to determine how an organization’s ESG scores rise or fall. Through such evaluation, investors can gauge how seriously an organization handles its risks.
ESG factors cut across the protection of individuals, society, and the environment. ESG also influences businesses and investment attractions, meaning the government should support strong ESG performance and disclosure. In turn, this would have a huge boost on investment competitiveness.
What is the secret sauce behind the ESG Ratings?
Essentially, ESG ratings are developed by commercial and non-profit organizations to determine how organizations’ performance, commitments, structures, and business models align with set sustainability goals. Investment firms use ESG scores to screen and evaluate companies in their respective funds and portfolios.
ESG ratings are also helpful to customers, job seekers, and other parties in evaluating business relationships to garner deeper insights into the organizations’ strengths, weaknesses, risks, and opportunities.
While the concept of ESG and its impact might seem simple, there’s still some confusion about what it means.
ESG ratings don’t necessarily gauge whether a highly rated organization is a leader in protecting the environment and reducing its impact on society and the planet or whether it strives to develop a sustainable world.
The truth is that ESG scores reflect how a company is proactively managing ESG risk. This provides crucial data on whether a firm’s environmental, social, and governance practices and policies will positively or negatively impact its shareholders or whether investors will earn superior returns.
Despite ESG’s associated effectiveness, there are growing concerns touching on its lack of transparency around data sources, methodologies, and potential conflicts of interest. There are ESG ratings agencies who advise companies they rate, an issue that leads to the lack of confidence from investors.
In November, the International Organization of Securities Commissions (IOSCO) issued a report revealing existing challenges with data product providers and the role and influences of ESG ratings. Evidence from this report indicated a lack of transparency regarding methodologies supporting the ESG ratings.
While there’s a lot to gain from ESG scores, what’s the difference between ratings agencies? While there are discrepancies within the ESG ratings framework, ESG scores are rated using the same scale ranging from 0-100.
- Excellent scores are anything above 70
- A good ESG score lies between 60-69
- The average ESG score lies between 50-59
- A poor ESG score is anything less than 50
ESG ratings are based on environmental, social, and governance factors.
Social rating scores look at issues like:
- Worker safety training
- Labor management
- Product safety and quality
- Consumer financial protection
- Supply chain labor standards
Environmental ratings focus on issues such as:
- Water sourcing
- Carbon emissions
- Toxic emissions and waste
- Electronic waste
- Packaging material and waste
- Biodiversity and land use
Governance issues include:
- Executive compensation
- Business ethics
- Tax transparency
- Board composition in terms of independence and diversity
MSCI ESG Ratings strive to evaluate an organization’s management of financially material ESG risks and opportunities. MSCI rating methodology is rules-based and identifies industry leaders, laggards, and those performing averagely.
MSCI ESG leader (AAA, AA) represents an organization that manages significant ESG risk factors and opportunities well.
Average MSCI ESG ratings (A, BBB, BB) portray a company with an unexceptional or mixed track record of managing ESG risks and opportunities compared to other companies within the industry.
Laggard ratings (B, CCC) represent a company lagging in the industry. It has high exposure and fails to manage significant ESG risks effectively.
ESG ratings help investors to make better investment decisions. Amazon, for example, is a leader in the business world. It has “BBB” MSCI ESG ratings. However, it performs averagely in its carbon footprint and poorly under labor management and corporate behavior.
Amazon’s poor performance in labor management and corporate behavior has had recent negative press. Complaints from Amazon workers surface from time to time. Reports usually cite challenges like blocking unionization, hazardous working conditions, and in some cases, mistreatment of workers.
The more aware of these factors you are and how they can affect potential returns, the more confident you will be that you are making the best investment for you.
Here are a few of the more frequently asked questions about ESG.
Materials ESG rating issues refer to governance, sustainability, or societal-related factors that can affect the operating performance or financial condition of a company within an industry.
It’s through ESG ratings that companies can enhance their relations with shareholders, access lower-cost capital, increase investments, and make strategic decisions effectively,
ITR from MSCI is a metric expressed in degrees celsius that details the temperature alignment of companies, funds, and portfolios with global temperature goals. ITR is used to determine decarbonization targets and enhance engagement on climate risk.
ESG organizations outperform their peers, which is expected to continue over time. With most companies striving toward sustainable investments, ESG ratings help investors to make more informed decisions concerning Environmental, Social, and Governance issues.
What’s more, ESG reporting helps to prove that organizations care about the community and its people, helps to gain greater transparency, increased accountability, and so much more.