Environmental, Social and Governance (ESG) factors are fast becoming a corporate priority. In large part, this is due to the changing priorities of banks, institutional and retail investors. Increasingly, evidence shows that companies that focus on ESG and investment portfolios that invest in these companies, simply do better. As a result, ESG investments are booming. Inflows into sustainable funds, for example, rose from $5 billion in 2018 to more than $50 billion in 2020—and then to nearly $70 billion in 2021.
At the core of this trend is the demand for transparent and reliable corporate ESG performance data, which these institutions need to inform their decisions. The problem is that ESG data is not always available, and even when it is, it’s hard to analyse. Quantitative data is often historical and highly contextual, while qualitative data – such as a company’s human rights policy – is hard to assess with traditional methods applied to financial data. This is where ESG rating agencies come in and the reason investors, asset managers, and financial institutions increasingly rely on external ESG assessments and rankings.
Just as credit ratings aim to measure a company’s creditworthiness based on a number of mostly financial criteria, ESG ratings aim to measure a company's exposure to environmental, social, and governance (ESG) risks and how effectively they manage those risks. This includes topics such as climate change adaptation, energy efficiency, employee health & wellbeing, diversity, equity, & inclusion (DE&I), and human rights.
Rating agencies score companies across a set of defined performance criteria across ESG as a measure of how sustainable a company is. A strong ESG rating typically indicates that a company manages its ESG risks well in comparison to its peers, whereas a poor ESG rating indicates that the company has comparatively higher unmanaged ESG risk exposure. ESG evaluations and scores, when combined with financial analysis, can help investors gain a better understanding of a company's long-term potential for positive, sustainable growth.
Because each ESG rating firm calculates scores based on proprietary algorithms and individual criteria, no two will score a company the exact same way. In general, ESG performance is based on data gathered from different sources, including securities filings, voluntary business disclosures, governmental databases, academic research, and media reports. As such, any ESG data that a business has made available through voluntary disclosure frameworks, such as the Global Reporting Initiative (GRI) or the Value Reporting Foundation’s (VRF) SASB Standards, can serve as a significant source of data for most rating providers.
With investors increasingly using ESG scores in their investment strategies, the consequences of a poor rating can be significant. Your ESG ratings are only as good as your ESG data and disclosures, meaning the more robust your data is, the better your ESG scores are likely to be. Do you want to get a better score? Are you looking to improve your ESG reporting? Talk to our experts.