The Different ESG Ratings and What They Mean

ESG
May 28, 2020

If you have ever wondered if environmental, social, and governance (ESG) ratings are useful to asset managers and investors, wonder no longer. Investors look at ESG ratings — sometimes weekly.

In addition to doing their own internal research to rank a company’s ESG performance, investors rely on official ESG ratings to supplement their data before making an investment.

This is one of many trends found in Rate the Raters 2020: Investor Survey and Interview Results, co-authored by Christina Wong and Erika Petroy, and released in March by SustainAbility/ERM, a sustainable economy think tank and advisory firm for businesses.

In addition to supplementing their internal research, investors use ESG ratings to identify leaders and laggards in the industry.

They also use ratings as a warning signal which may indicate a discrepancy between what the investor expected and what the numbers say; or where a company needs to improve; or perhaps as an indicator that the investor should do more research on a particular business.

And then, some investors just use the ESG data instead of the actual rating.

A large range of ESG integration techniques exist across investment/asset management firms, Wong and Petroy write. Some have fully embedded ESG, while others are just starting to apply it. These differences in approach impact both how firms use ESG ratings and how they engage companies. But the numbers are being used in some fashion.

“We predict more and more investors and asset managers will move towards full ESG integration in the future,” they say. Although they expect that is still several years away.

What does this mean for a company?

It is important for companies to identify the needs of their investors.

In a webinar on the topic, Wong says that businesses should ask investors how they are using ESG ratings and data, and what would they like to see from the company.

Wang stressed that a company also needs to know its ESG benchmark and where it falls in relation to one’s peers. Wang says that knowing one’s benchmark is especially important if one finds its business on the red list, for example. If this happens, companies need to get in touch with their investors immediately to explain what is going on and how the problem will be solved.

Differing ranking systems

It is also important for companies to understand how ESG ratings differ from one system to another.

The report suggests that MSCI, Sustainalytics, the ISS QualityScore and CDP are perhaps the most important scores to report as these are of high utility.

MSCI was one of the most often mentioned ratings by investors because of its broad coverage. One of those surveyed wrote, “Because we don’t take ESG ratings out of the gate, we also combine them with fundamental research, we really like MSCI because of the qualitative reports that accompany scores – that transparency gives a better understanding of how they got the score. If we disagree, we can make adjustments.”

Sustainalytics, like MSCI, is a popular rating system known for its broad coverage and transparency. One commenter said that it is “stronger on core sustainable performance in the classical sense.”

Two ISS ratings got specific praise: the ISS QualityScore (particularly the Governance score) and ISS-Ethix. “Multiple investors noted ISS has the ‘best governance reports,’ the best research on proxy reporting, and the best negative screening on ethical criteria,” wrote Wong and Petroy.

Most investors reported they used CDP more for its data than its analysis. One investor said, “The carbon, water, etc. information is sometimes useful at a sector-level, but sometimes comparability can be an issue.”

However, no matter what rating system a company uses, Wang cautions that these numbers “should not take the place of direct disclosure/reporting and engagement with investors.”

Is it worth obtaining the RobecoSAM CSA?

SustainAbility encourages companies to consider whether participation in the CSA is worth the time and effort it takes to complete.

The SAM Corporate Sustainability Assessment (CSA) is an annual evaluation of companies’ sustainability practices. It is issued by S&P Global and is the rating underlying the Dow Jones Sustainability Indices (DJSI).

The authors of Rate the Raters suggest that the worth depends on whether or not a company is new to ESG reporting or already has an established process. It may be a great practice if new, as this would help educate internal stakeholders, build internal processes for gathering ESG data, and may even instigate discussions on ESG management issues. However, if a company already has advanced ESG management practices, performance evaluations, and disclosure practices, one’s efforts may be better directed at “direct investor engagement.”

The report cautions, “While the CSA set a record for responses in 2019 with over 1,100 companies participating, the value derived from participation varies considerably and the time required should not be invested automatically.”

What investors want to see

Investors agree that ESG ratings and rankings are here to stay. However, for them to be effective indicators, the quality and disclosure of rating methodologies need to improve; a greater focus must be placed on material issues; and reports need to make a stronger link to a company’s financial performance.

If one has any questions about ratings — theirs or their peers — it is fine to ask for help. Companies, such as SustainAbility/ERM, help businesses prioritize which ESG ratings are most critical and develop response strategies for specific ratings.

For more information, check out the full Rate the Raters 2020 report.

Author

Laurie Toupin