Business leaders, investors, regulators, researchers, and the public are gaining consensus in that traditional financial metrics only tell part of a company’s story. A company’s ability to demonstrate how environmental, social, and other trends impact its strategy, operations, and long-term growth is important to meeting the needs of both shareholders and stakeholders.
Thus, environmental, social and governance (ESG) issues have increasingly been taking a center stage for companies large and small and capturing the attention of boards, consumers and stakeholders alike. Much of this attention has been generated by third-party rating and reporting organizations who have developed ways of measuring companies’ progress on ESG topics to drive investment decisions.
According to a report by KPMG, thousands of companies in more than 50 countries have already established an ESG system, which includes 82% of companies in the United States.
Part of the challenge for business leaders is the temporal aspect of what’s being measured and how fast the target is moving. Therefore, ESG reporting and ratings can take out some of the complexity of evaluating a company’s ESG activities and impact. As ESG standard benchmarks evolve, independent ESG scores provided by third parties will continue to serve as highly relevant reference points.
Simply put, ESG scores matter to investors, stakeholders and the business community at large. Boards must know what goes into them and how to manage them. These scores increase or degrade a company’s ability to attract capital and set a tone internally and externally on how ESG activities are communicated.
What is an ESG score?
Just like credit scores signal to a consumer’s potential ability to pay back debt, an ESG score gauges a company’s performance on ESG issues and exposure to ESG-related risks. They are calculated against a set of ESG metrics and may be expressed on a number scale or through a letter ranking system. According to the Harvard Law School Forum on Corporate Governance, such reports ‘often form the basis of informal and shareholder proposal-related investor engagement with companies on ESG matters.
Who are the ESG rating agencies?
Although there are a number of agencies who are leading the way on ESG score reporting, it’s just as important to remember how fast-moving this space is. We expect to see more organizations bring different perspectives and frameworks to this task; moreover, as the SEC signals to its updated ESG-related requirements, there will be much greater compliance focus on these matters.
Several third-party providers, be it an agency, research or analytics firm, evaluate companies on their ESG performance and determine independent ESG scores for investment decisions and comparisons against their peers and the broader market. Examples include:
Bloomberg ESG Data Services – Offers ESG data for more than 11,700 companies in 102 countries
Corporate Knights Global 100 – An annual global ranking of corporate sustainability performance by Toronto-based magazine Corporate Knights
MSCI – An MSCI ESG Rating is designed to measure a company’s resilience to long-term industry material ESG risks
Refinitiv – Offers a comprehensive ESG database, which covers ~70% of the global market cap across 500 different ESG metrics
Sustainalytics ESG Risk Ratings – Designed to help investors identify financially material ESG risks for more than 12,000 companies
Dow Jones Sustainability Index Family – Headlined by DJSI World, which represents the top 10% most sustainable companies among the largest 2,500 in the S&P Global BMI
Thomson Reuters ESG Scores – Measures ESG performance across 10 themes for more than 6,000 companies
RepRisk – Uses AI and Machine Learning to compile coverage of ESG risk assessment for more than 160,000 public and private companies
What does good look like?
As we are largely pre-compliance in the world of ESG reporting and metric tracking, there are all shapes and sizes to what “good” looks like. Methodology, scope, and coverage vary significantly among each agency. Bloomberg and Corporate Knights rate companies on a 100-point scale, for example. Thomson Reuters assigns a score between 0 (worst) and 1 (best) with a corresponding letter grade. RepRisk measures companies on the RepRisk Index (0 to 100) and provides a RepRisk rating (AAA to D).
A general rule of thumb is that any score below 50 is considered poor, while anything above 70 would be considered a good score.
What are the benefits of a good ESG score?
Data shows that an increase in an ESG score correlates with increases in innovation, productivity and profitability. This is no surprise to those who have been thinking about broader stakeholder engagement, especially for companies who have focused on their employees. In companies with higher scores, employees are more engaged, willing to take more risks and innovate.
Moreover, there are evidenced benefits to the environment – whether it is in waste reduction, energy efficiency, decreased emissions, etc.
What are the scoring criteria?
One of the points of synergy across the different scoring agencies is the delineation of the areas across the three dimensions – Environmental, Social and Governance.
1. Environmental Scoring Factors – These ranges from a company’s greenhouse gas emissions to its treatment of animals and water efficiency. Common criteria include:
Soil and water contamination
2. Social Scoring Factors – Is often the more challenge aspect to measure, which focuses on a company’s business relationships with employees, suppliers, partners, shareholders, communities and groups across a supply chain:
Are workers in factories abroad treated ethically?
Do employees earn a living wage?
Are facilities regularly inspected and safe to work?
Can employees take leave when they are sick or for other personal reasons?
3. Governance Scoring Factors – These topics related to legal, compliance and board operations:
Does the company abide by all local, state and federal laws?
Does board compensation represent diverse backgrounds and perspectives?
How does executive and non-executive compensation compare to the company’s peers?
Depending on the agency/scoring framework, industry matters. Corporate Knights, for instance, only scores companies based on performance indicators that are only germane to the given industry.
How is an ESG score calculated?
The ESG score is the outcome of many parameters on which the company’s performance is being evaluated. Each rating agency has a different method.
Worth noting is the difference between ESG Scores and ESGC Scores, in that the latter takes into the account ESG-related “controversies” that would discount an ESG performance score. ESGC scores are calculated on a variety of ESG controversy topics and measures a company’s exposure to environmental, social and governance controversies and negative events reflected in global media. During the year, if a scandal occurs, the company involved is penalized and this affects their overall ESGC scores and grading. The impact of this event may still be seen in the following year if there are new developments related to the negative event, for example, lawsuits, ongoing legislation disputes or fines.
Who has access to a company’s ESG score?
Like many of our questions on ESG scores, it depends. Some ESG ratings and reports are in the public domain, while others, like Bloomberg and RepRisk, are designed for investors to direct their investment decisions.
Some organizations engage directly with companies to verify data before sending ESG scores to investors with feedback on how they can improve their scores and ESG performance.
How can companies get started with ESG?
With more global leaders recognizing the risks related to climate change, expect to see all businesses come under scrutiny for their ESG practices. The best way to avoid any negative attention is to get ahead of the curve, by learning how to write a report before you are asked if you have one.
Where do you stand in your journey toward sustainability, climate leadership, and ESG investment/reporting?
See additional resources below: