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For the uninitiated, ESG scores can seem complex to navigate. This executive primer is designed to demystify and answer the key questions around ESG scores.
Over the past few years, consensus has begun to build within the business community around the belief that traditional financial metrics alone are not sufficient to tell a company’s full story. Instead of relying purely on financial indicators, many investors, regulators, and consumers alike are beginning to stress the need for companies to demonstrate how they perform across and are influenced by a wide range of environmental, social, and governance (ESG) topics.
Much of the attention that ESG has gained of late has been propelled by third-party rating and reporting organizations who have developed ways of measuring and distilling companies’ performance on ESG metrics in an effort to help ESG-focused investors make more informed investment decisions. Part of the challenge for business leaders in seeking to maintain positive ESG performance, however, is the temporal aspect of what’s being measured and how quickly the target is moving. As such, ESG reporting and ratings can serve an important role in reducing 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.
With this backdrop, it is becoming increasingly clear that ESG scores matter to investors, stakeholders, and the business community at large. As such, it is becoming incumbent upon executives and boards across the world to know what goes into ESG scores and how to manage them, as these scores can either upgrade or downgrade a company’s ability to attract capital and set its tone to the market.
The rest of this article is designed to provide an overview of ESG scores and how businesses can improve theirs.
What exactly is an ESG score?
Simply put, ESG scores gauges a company’s performance on issues and exposure to ESG-related risks. The score itself, which can be expressed as a number or letter grade, is an aggregate or composite of the company’s performance across a wide range of metrics, which can range from how much CO2 the company emits per employee to what the share of female representation on the Board is. As such, a company’s ESG score becomes a conveniently succinct basis on which shareholders and stakeholders can begin to engage with the company on ESG matters.
Who are the ESG rating agencies?
Although there are a number of agencies who are leading the way on ESG scoring, it is equally important to recognize how rapidly evolving the space is, implying that the leaders today may not be the same tomorrow. 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 evaluate companies on their ESG performance and determine independent ESG scores for investment decisions and comparisons against their peers and the broader market. Some of these providers 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?
Because the ESG field is still evolving and wide-ranging regulations have yet to be enacted globally, a consensus understanding of what “good” looks like has yet to be developed. Methodology, scope, and coverage vary significantly from rating agency to rating agency. For example, Bloomberg and Corporate Knights rate companies on a 100-point scale and use their own set of metrics while Thomson Reuters assigns companies a score between 0 (worst) and 1 (best) with a corresponding letter grade and RepRisk measures companies on the RepRisk Index (0 to 100) and provides a RepRisk rating (AAA to D).
Although it can be difficult to deduce exactly what constitutes a good score in each case, a general rule of thumb is that any score below 50 (or some equivalent thereof, like 0.5 out of 1) is considered poor, while anything above 70 or equivalent would be considered strong.
What are the benefits of a good ESG score?
Several studies have shown that higher ESG scores are correlated with increased in innovation, productivity, and profitability for companies. This may come as no surprise to those who have been thinking about broader stakeholder engagement, especially for companies which have focused on their employees. In companies with higher ESG scores, employees are more engaged, willing to take more risks, and innovate. Moreover, there are clear benefits to the environment and resource efficiency, including waste reduction, energy efficiency, and decreased emissions.
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 can range from measuring a company’s greenhouse gas emissions to its treatment of animals and water efficiency. Common criteria include:
- Climate change
- Soil and water contamination
- Renewable energy
- Environmental policy
2. Social Scoring Factors – Social factors are often among the more challenging to measure, as they tend to focus on a company’s business relationships with employees, suppliers, partners, shareholders, communities, and groups across a supply chain. Typically, they tend to gravitate around answering several key questions, including:
- Are workers across the supply chain being treated ethically?
- Are employees being given a living wage?
- Are facilities regularly inspected and safe for work?
- Can employees take leave when they are sick or for other personal reasons?
3. Governance Scoring Factors – These topics relate to legal, compliance, and board operations, typically addressing questions which include:
- Does the company abide by all local, state, and federal laws?
- Do board members represent diverse backgrounds and perspectives?
- How does executive and non-executive compensation compare to the company’s peers?
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.
It is worth noting, however, that there is a 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 measure 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 those from 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:
