What your ESG rating really means€¦ · be combined in the future. VISIT WEBSITE → Methods:...

W H A T E S G F R A M E W O R K U S E R S A R E S A Y I N G 1

What your ESG rating really means

Your guide to understanding ESG scores

A note from the author

A brief history of ESG ratings

The ESG ratings landscape at a glance

Do ESG ratings really matter?

How to improve your ESG ratings

The future of ESG ratings

2

4

7

15

17

22

I N T H I S G U I D E

A N O T E F R O M T H E A U T H O R 2

A note from the author

Any effort to mitigate the impacts of climate change and related crises is going to involve

sustainable finance. That means investors, fund managers, boards of directors, and other

stakeholders in global financial markets must put the planet and people above profits, and

start prioritising investments that make sense for a sustainable future.

While that might seem like a pipe dream, the truth is we’re off to a shockingly good start.

A 2019 study from KPMG found that the global value of sustainable investments being

professionally managed was estimated at $30 trillion — that’s a 34% increase in just

two years.

Is that enough? Not even close. In the same report, KPMG found that to limit global warming

to 1.5 degrees by 2030, an investment of $90 trillion is needed.1

Still, it can’t be argued that the trend lines are at least pointed in the right direction. No

matter where you look, ESG (environmental, social, and governance) topics are becoming

more important to investors.

Deloitte research has found that globally, the percentage of both retail and institutional

investors that apply ESG principles to at least a quarter of their portfolios jumped from 48%

in 2017 to 75% in 2019.2

The impact of this shift is tangible. According to Morningstar, one-third of overall assets

under management in the U.S. is now subject to some type of sustainable investment

strategy, and sustainable fund flows accounted for nearly a quarter of overall cash flows into

U.S. funds in 2020.³

A N O T E F R O M T H E A U T H O R 3

This continued interest in and adoption of ESG principles by investors shows a clear demand

for sustainable business practices — and, subsequently, methods for understanding and

analysing the sustainability of a given business.

ESG ratings attempt to meet this demand by letting investors quickly and easily assess the

ESG performance of a business using a standardised letter grade or numerical scoring system.

That’s great in theory, but as it stands now, ESG ratings still have a long way to go. There’s a

need for higher-quality data, more transparency, and a more universal ratings system.

Because ESG ratings are primarily a product for investors, the companies that provide these

ratings don’t offer much education for the companies being rated. Still, it’s important for

business leaders to understand ESG ratings and how they should be integrated into a larger

ESG strategy.

We put together this guide to help fill this gap. Hopefully, it helps you understand what ESG

ratings are, how they’re used, and whether you should really worry about your scores.

All the best,

D A N I E L B O T T E R I L L

CEO, Rio ESG

A B R I E F H I S T O R Y O F E S G R A T I N G S 4

A brief history of ESG ratings

ESG ratings aim to measure an entity’s exposure to environmental, social, and governance

risks, as well as how effectively they manage those risks.

They are most commonly applied to publicly traded businesses, though some providers also

rate countries/governments and funds.

Ratings are typically calculated via a weighted set of criteria, with weighting typically set at the

industry/sector level. So for example, a rating for an oil company will be calculated differently

than a rating for a financial services firm.

ESG ratings have been around in some form since the late 2000s, but the landscape has

been in a near-constant state of rapid change due to mergers, acquisitions, and new market

entrants.

In addition, the ESG ratings market is not neatly defined. Providers typically also offer other

kinds of ESG data, including benchmarks, indices, and rankings, and these data types can

serve similar purposes for investors.


Ratings, indices, and benchmarks, oh my.

ESG rating A scored or graded evaluation of a company

based on an assessment of its performance

on ESG issues.

ESG index A group of stocks tracked by ESG performance,

used to research investments and create ETFs

and other investment products.

ESG benchmark

An assessment of an organisation’s ESG

performance as compared to its peers and/

or competitors, usually accompanied by

recommendations for improving performance.

ESG ranking A list of companies ordered or grouped

based on relative ESG performance

according to specified ESG metrics.

ESG framework

Standards used to guide the reporting and

disclosure of ESG metrics by an organisation.

Frameworks are created and maintained by

various nonprofits, NGOs, and industry groups.


Worldwide, there are more than 600 ESG ratings and rankings, according to SustainAbility.4

These rankings vary widely in coverage (the entities in their ratings database), outputs, and

methodologies.

Not all of the 600+ ratings are equally important. Over time, six ratings providers have emerged

as market leaders:

· Morgan Stanley Capital International (MSCI)

· Sustainalytics

· Refinitiv

· S&P Global Ratings

· FTSE Russell

· Institutional Shareholder Services (ISS)

Even among these top six providers, there is significant variation in where they get their data

and how they calculate ratings.

Data collection methodologies in this group include questionnaires, human analysis,

AI-based processing of sustainability reports, and compilations of publicly available

information. The methods for processing data to generate ESG ratings also vary widely,

and are usually opaque.

While some ratings providers have proprietary data sources, most rely heavily on the ESG

metrics that are self-reported by businesses in CSR or sustainability reports. And although

this reporting is becoming more common — 90% of the S&P 500 reported on sustainability in

20195 — there is very little accountability and verification in this field.

As a result, ESG ratings — as they exist today — aren’t exactly hard science.

For this reason, business leaders are often surprised when they encounter their own ratings,

which might seem unfairly low or otherwise inaccurate.

7T H E E S G R A T I N G S L A N D S C A P E A T A G L A N C E

The ESG ratings landscape at a glanceIt’s important to keep in mind that the ESG ratings landscape tends to shift rapidly due to

consolidation, changes in scope or methodology, and even legislation.

As of this writing, there are six big players in ESG ratings, as well as a group of secondary

providers that have value for certain niches or that threaten to disrupt the big six. You’ll find an

overview of each of these providers below.


MSCI has been one of the major

drivers of consolidation in the

ESG ratings space, acquiring

several competing data providers

since its entry on the scene. In

addition to businesses, MSCI

also rates countries and financial

products like securities, loans,

mutual funds, and ETFs.

V I S I T W E B S I T E →

Methods: Analysis of publicly available

reporting, plus proprietary ESG data

Coverage: 8,700+ companies

Clientele: 1,400+ clients, including 46 of

the top 50 global asset managers

Key issue coverage: 35 key issues, 6-10

identified per industry (materiality is

determined at industry level)

Scoring: Leader (AAA, AA), Average (A,

BBB, BB), Laggard (B, CCC). Calculations

are made via a weighted average of each

score level that’s then adjusted relative

to peers.

Morgan Stanley Capital International (MSCI)

Image source: MSCI

https://www.msci.com/our-solutions/esg-investing/esg-ratings


Sustainalytics started as an

independent ratings provider, but

since 2020, it is wholly owned

by Morningstar. In addition to

comprehensive ESG ratings for

businesses, it also offers carbon-

specific, governance-specific, and

country ratings. Sustainalytics

makes many of its ratings

available via a simple search on

its website.


Methods: Automated analysis of

ESG reports using natural language

processing


Key issue coverage: 20 ESG issues, up to

10 issues per company

Scoring: Negligible (0-9.99), Low (10-

19.99), Medium (20-29.99), High (30-

39.99), Severe (40-100)

Sustainalytics

Image source: Sustainalytics

https://www.sustainalytics.com/

1 0T H E E S G R A T I N G S L A N D S C A P E A T A G L A N C E

Refinitiv is now a subsidiary

of the London Stock Exchange

Group (LSEG), after being sold

by previous owners Blackstone

and Thomson Reuters. Its ESG

Scores are just one part of

a much broader suite of risk

analytics solutions. Since the

LSEG acquisition, Refinitiv is now

a sister company of FTSE Russell.

It’s unclear whether the two

companies’ ratings solutions will

be combined in the future.


Methods: Combination of human and

algorithmic data collection and analysis


Clientele: 40,000+ customers globally

Key issue coverage: 10 ESG topics

Scoring: A-/A/A+ (Excellent), B-/B/B+

(Good), C-/C/C+ (Satisfactory), D-/D/D+

(Poor). Weighted category score sums (for

the 10 ESG topics) go into Pillar scores.

Deductions are made based on ESG

controversies for a final combined ESG

score.

Refinitiv

Image source: Refinitiv

https://www.refinitiv.com/en/sustainable-finance/esg-scores


Credit ratings giant S&P also

offers ESG Evaluation services.

In 2020, it acquired the SAM

ESG Ratings and Benchmarking

business from RobecoSAM,

whose Corporate Sustainability

Assessment is also used as

the basis for the Dow Jones

Sustainability Index (DJSI).


Methods: Web-based questionnaire in

addition to analysis of publicly available

ESG reporting


Key issue coverage: 58 ESG issues,

23 criteria identified per company on

average

Scoring: 1 to 100, where 100 is best.

Sub-level scores (such as Media &

Stakeholder Analysis or Criterion) are

progressively weighted and summed until

an aggregate score is reached.

S&P Global Ratings

Image source: S&P Global via Twitter

https://www.ftserussell.com/data/sustainability-and-esg-data/esg-ratings


FTSE Russell is a subsidiary

of the London Stock Exchange

Group (LSEG), and is primarily

known for its stock market

indices. It maintains its own

ratings solution, but is also a

sister company of Refinitiv as of

2021. It’s unclear whether the two

companies’ ratings solutions will

be combined in the future.


Methods: Human analysis of publicly

available ESG reporting, plus contact

with rated companies

Coverage: ~4,700 companies

Key issue coverage: 14 themes (10-35

indicators per theme on average), 125

indicators per company on average

Scoring: 1 (company is in the bottom 1%)

to 100 (company is in the top 1%). Each

theme is given an exposure figure and a

score; the weighted average of the theme

scores is the Pillar score. A weighted

average is applied to the Pillar scores to

determine a final rating.

FTSE Russell

Image source: FTSE Russell

https://www.ftserussell.com/data/sustainability-and-esg-data/esg-ratings


ISS is the world’s largest proxy

advisory firm. It entered the ESG

ratings space after acquiring

Oekom Research AG in 2018.


Methods: Human analysis of publicly

available ESG reporting, plus contact with

the company and stakeholder interviews


Clientele: 180+ clients worldwide

Key issue coverage: 13 ESG topics,

800 indicators with approximately 100

indicators used per company

Scoring: A-/A/A+ (Excellent), B/B/B+

(Good), C-/C/C+ (Medium), D-/D/D+ (Poor).

Prime status is given to companies with a

rating above the sector-specific threshold.

Institutional Shareholder Services (ISS)

Image source: ISS ESG

https://www.issgovernance.com/esg/ratings/


SenseFolio: Tracks and assesses 30,000+ companies’ ESG involvement

via natural language processing and machine learning algorithms. Scoring

is aligned to SenseFolio’s own framework or to GRI, SASB, or the U.N.

SDGs.

Vigeo Eiris: Evaluates organisations’ integration of ESG factors into its

strategies, operations, and management. Moody’s acquired a majority

stake in the company in 2019.

Ecovadis: Evaluates how well a company has integrated the principles of

sustainability/CSR into business and management systems and focuses

on sustainable procurement/the sustainable practices of a company’s

supply chain.

Bloomberg: Offers “ES scores” designed to measure the environmental

and social performance of a company (launched in 2020 starting with

the oil and gas sector) as well as governance scores focused on board

composition.

Arabesque: Uses a quantitative data tool that analyses sustainability

performance using self-learning models. Scoring is based on the four

core principles of the U.N. Global Compact. Temperature scores are given

based on alignment with 1.5 degrees scenario.

Additional notable smaller/emerging ratings providers include Clarity AI,

Owl Analytics, Truvalue Labs, and Akadia.

Secondary ESG ratings providers

1 5D O E S G R A T I N G S R E A L L Y M A T T E R 1 5

Do ESG ratings really matter?

ESG performance is undoubtedly important to investors — not to mention, to customers,

regulators, employees, and other stakeholders — but ESG ratings are not synonymous with

ESG performance.

It’s worthwhile for an organisation to ask itself just how much time, energy, and resources it’s

willing to invest into earning a high ESG rating.

Make no mistake: Investors are using ESG ratings. In a SustainAbility global survey of 500

investors from 17 firms, 95% said they use ESG ratings, and 65% said they use them on a

weekly basis. Many investors also noted that they use more than one ratings source.4

But most investors are also aware of the shortcomings of ESG ratings data, so not all will use

ESG ratings as a definitive source of truth.

Because of the wide variety of ratings methodologies and the varying quality of data sources,

different ratings can be widely divergent from one another. A 2019 MIT Sloan report found that

the correlation among independent agencies’ ESG ratings was on average 0.61; by comparison,

credit ratings from Moody’s and Standard & Poor’s were correlated at 0.99.6

In fact, in the SustainAbility survey, most respondents described using ESG ratings more for

the underlying data and not the scores — the ratings are merely a starting point for many

investors, who reported doing their own research, and even compiling their own scores based

on data from the ratings providers.4

D O E S G R A T I N G S R E A L L Y M A T T E R 1 6

“ We believe the value in ESG scores are the underlying data and not the final

scores. As soon as various metrics get weighted and aggregated to achieve

a single score, valuable detail gets lost and can even hide a bad result

that might be important to a certain investor. We find much more value

in comparing the underlying metrics making up the score and how each

company compared to its peers. That’s where real improvements can be

made.

S A N N E G R O U P

Karlien De Bruin, Global Head of ESG

Another reason why ESG ratings are not yet a perfect solution for investors is that they’re not

available for all companies. Most big ratings providers cover most large-cap companies, but

small- and mid-cap companies are either not rated at all, or, because they’re less likely to be

engaged in comprehensive ESG reporting, rated inaccurately.

The bottom line: One bad ESG rating probably won’t ruin a company, especially if the low rating

is due to a lack of data or misinterpretation of actual ESG performance.

However, as ratings adoption continues to increase and ratings methodologies improve, ESG

scores are likely to become more important, so it’s worth keeping on top of them.

H O W T O I M P R O V E Y O U R E S G R A T I N G S 1 7

How to improve your ESG ratings

Given the information we’ve covered so far, a company that’s actively pursuing ESG goals and

working toward sustainability might conclude it doesn’t need to worry about ESG ratings until

it receives a bad score.

However, existing processes for engaging with providers to fix a mistaken score are often

cumbersome and difficult. For this reason, it’s much better to take a proactive approach to

achieving good scores. That means understanding what kinds of data providers are looking

for, disclosing that data, and making it available where providers are looking.

The first step is to use a widely adopted ESG framework for reporting. We recommend the WEF

Stakeholder Capitalism Metrics, but there are many frameworks to choose from.

Disclosures should be publicly available, clearly labeled, and easily accessed from your

website. Remember, most ratings providers are relying on this kind of data, whether it’s

accessed by a human being or scraped by an AI. Plus, most investors are doing their own

research to confirm the findings of the ratings providers, and this is the first place they’ll look.

It’s also critically important to understand which ESG metrics are material to your

organisation. All ESG ratings providers are attempting to weigh ESG risk by materiality — how

important an issue is to the business’s stakeholders and future success. By aligning your ESG

initiatives to a good materiality assessment, you’ll almost certainly end up aligning with

ESG ratings in the long run.

To summarise, the best way to get a good ESG score is to earnestly comply with the spirit of

ESG: simply be more sustainable and more transparent.

For more information, read our guide to choosing an ESG framework.

1 8

“ We use our ESG data analysis and ratings to strategically align ourselves

for the future to ensure that ESG is at the forefront of our business choices,

the selection of our supply-chain and also that of our customers. One of our

unique selling points is our effective engagement with customers to share

ESG analysis for their wastes to provide them with the data to make effective

business decisions and inform their sustainability disclosure.

We have been able to identify areas where we are very strong through our

ESG experience and the ratings applied to our disclosure, for example our

approach to health and safety, compliance, and management of risk; and

it has also generated ideas on where we can improve. We have been able

to incorporate this feedback into our internal and external processes to

improve disclosure even further including embedding it into our annual CSR

report which allows our stakeholders to understand our performance and

sustainability intentions for the future.

We look forward to implementing further plans and targets that are

underpinned by the underlying data that contributes to ESG ratings to expand

our portfolio of ESG disclosure to provide assurance to our key stakeholders

including our customers, supply-chain and our investors, to minimise risk and

maximise growth potential.

Augean Plc

Gary Bower, Director of Corporate Stewardship

H O W T O I M P R O V E Y O U R E S G R A T I N G S

1 9

However, if ESG ratings are really important to your business, you might decide to take a more

targeted approach. Here’s a step-by-step guide to improving ratings:

STEP 1

STEP 2

Figure out which ratings providers are covering your business.

While most ratings providers will cover the world’s largest publicly traded

companies, coverage gets sparser as you decrease in market cap. Private

companies may not be rated at all, or by only one or two providers.

Finding out if you’re covered can be tricky; different providers have different

methods for sharing ESG scores, and some may provide your score only if you

contact them. Only a handful have free searchable databases.

Of the ratings providers that cover your business, determine common ground

for material topics.

Not all ratings providers account for all ESG topics, and the topics they do cover

are weighted differently based on materiality, usually at the industry/sector level.

What this means is that improving performance (and, subsequently, transparency

and reporting) in one area could have a much larger impact on your ratings than a

similar improvement in another area.

By cross-referencing ratings providers’ assessment methodologies, you can

determine which topics are weighted most heavily by the greatest number

of raters (and learn how they calculate performance in these areas). But be

prepared to do some digging, because this information is not always easy to find.


2 0

Common topics assessed by ESG ratings providers

Environmental

· Carbon emissions

· Biodiversity

· Water impact/risk

· Supply chain impact

· Energy management

· Land use

· Pollution

· Resource use

Social

· Occupational

health & safety

· Human rights

· Labor standards

· Supply chain labor

· Equal opportunities

· Product safety

· Data privacy

Governance

· Business ethics

· Board (composition,

compensation,

independence)

· Risk management

· Tax strategy


STEP 3

Prioritise investments in transparency and performance in material areas.

Once you determine which ESG topics are considered most material for your

business by the ratings providers, you can focus your efforts on improving

performance and reporting in these areas. In the long run, this should reflect as

an improvement to your ESG scores.

2 1

STEP 4

Use a software solution like Rio to understand, track, and report on your ESG

data.

Despite their differences, one commonality of all ESG ratings is their dependence

on high-quality data. If your organisation is unable to track ESG metrics and

produce reliable, accurate, and frequent ESG reports, raters may not be able to

accurately rate you, and they might even dock points for lack of transparency.

Unfortunately, for many small and midsize businesses, a lack of reporting isn’t for

lack of trying. It takes a significant amount of time and resources to collect and

process ESG data in the formats that ratings providers are looking for.

Software like Rio can help make this process easier. Rio offers one streamlined

platform for all your ESG-related data to help you stay organised and manage

your reporting and disclosures. Our solution allows for importing and processing

quantitative data, as well as storing and managing qualitative data. It even helps

you automatically build reports based on popular frameworks.


A B R I E F H I S T O R Y O F E S G R A T I N G S 2 2T H E F U T U R E O F E S G R A T I N G S 2 2

The future of ESG ratings

ESG ratings are far from perfect, certainly, but all signs point to these scores becoming

increasingly important in the coming years.

As sustainability reporting improves, ratings technology and processes get better, and ESG

becomes an even more salient topic, investors will begin to assign more value to ESG ratings.

In the next few years, we also predict the emergence of ESG ratings in private markets,

stronger regulation of scoring and assessment (which is already happening in the EU)7, and

further innovation from both the major ratings providers and smaller boutique ones as they

figure out how to glean new insights from different data sources.

In addition, there’s no reason to believe the rate of change in the ESG rating market will

slow down. Mergers, acquisitions, and partnership agreements might lead to increased

consolidation, which could be a good thing, in that it might produce more standardised and

reliable ratings.

A B O U T R I O 2 3

About Rio

Rio is an intelligent, accessible sustainability software platform that helps businesses and

individuals become more sustainable through data analysis, learning, and governance.

Rio’s proprietary AI analyses your data and provides transparent, actionable recommendations

for reducing environmental impact, managing ESG risk, and saving money on waste, energy,

water, and more.

Rio takes knowledge from the sustainability sector’s leading minds and puts it into the hands

of everyday people and organisations — so we can all do better together.

Here’s a preview of what you can do with Rio:

Get in touch. 0203-371-7630 | www.rio.ai | [email protected]

Get intelligent recommendations

Rio provides transparent, actionable recommendations for improving environmental impact, managing ESG risk, and saving money on waste, energy, water, and more.

Similarly to how a consultant would provide recommendations, Rio’s proprietary AI compares your sustainability data and current practices with expert sustainability knowledge to create a comprehensive report that gives you trustworthy advice.

Achieve your sustainability goals

Rio acts as a central hub for your sustainability data, allowing you to track financial, compliance, and governance information at the transaction level. You can use Rio’s sustainability governance features like the legislation library, reporting and disclosure frameworks, and ESG policy tools to help you develop your standards and manage your progress.

Learn about ESG

Rio Engage, our built-in e-learning platform, provides lessons on sustainability through multimedia content that’s accredited by CPD UK and recommended by IEMA. Use it to continue your own professional development or manage a whole team of learners with our full-featured learning management system.

W H A T E S G F R A M E W O R K U S E R S A R E S A Y I N G 2 4A B O U T R I O 2 4

Links

1. https://assets.kpmg/content/dam/kpmg/uk/pdf/2019/07/numbers-

that-are-changing-the-world.pdf

2. https://www2.deloitte.com/us/en/insights/industry/financial-

services/esg-investing-performance.html

3. https://www.morningstar.com/articles/1019195/a-broken-record-

flows-for-us-sustainable-funds-again-reach-new-heights

4. https://www.sustainability.com/thinking/rate-the-raters-2020/

5. https://www.ga-institute.com/research-reports/flash-reports/2020-

sp-500-flash-report.html

6. https://mitsloan.mit.edu/ideas-made-to-matter/why-esg-ratings-

vary-so-widely-and-what-you-can-do-about-it

7. https://www.esgtoday.com/european-securities-and-markets-

authority-calls-for-regulation-of-esg-ratings/

What your ESG rating really means€¦ · be combined in the future. VISIT WEBSITE → Methods:...

Documents

Transcript of What your ESG rating really means€¦ · be combined in the future. VISIT WEBSITE → Methods:...