This article is sponsored by Isometrix.
Businesses and investors must navigate many variables when managing Environmental, Social, and Governance (ESG)-related initiatives, reports and investments for stakeholders. These include regulations, reporting standards and frameworks, and public sentiment. ESG scoring is one prominent but frequently misunderstood component of corporate sustainability.
ESG topics are often subjective, and ESG scoring helps quantify and standardize performances to enable benchmarking and comparisons. Ignoring ESG scores can lead to missed opportunities for businesses and investors seeking to meet stakeholder needs and bolster their bottom line through sustainable practices. Mastering ESG scores — understanding why and how they are used — will help organizations factor their influences when incorporating ESG into their corporate strategy.
Who calculates ESG scores?
There are more than 140 ESG rating agencies in the U.S. alone, according to Investopedia. Most investment and advisory firms offer ESG scores and ratings as means to provide investor guidance, create reputable ESG funds or sell services that will help improve ESG scores. Some of the most well-known and respected ESG scores come from institutions such as Morgan Stanley Capital International (MSCI), Sustainalytics (a Morningstar company), S&P Group, ISS, Bloomberg and Refinitiv. Notable exceptions from different backgrounds include CDP and EcoVadis, which will be covered in Part 2 of this article series.
Many of these firms start with a similar approach when evaluating ESG performance, yet their calculations and scoring methodologies can vary greatly. As such, it is essential for organizations to be aware of the different evaluation processes to achieve consistency with their ratings.
How are ESG scores calculated?
Unfortunately, the exact criteria and calculations behind most ESG scoring methodologies are not publicly disclosed. However, you can easily adopt a few best practices to give your company a better chance at scoring well on ESG ratings.
Firstly, recognize that most rating methodologies will only include publicly disclosed information whether reporting directly to the firm is part of the grading process, such as with S&P, CDP and EcoVadis, or the firms scrape the internet for a company’s disclosures and news stories using AI tools to assist in constructing the profile.
The best first step to take to improve your score for any methodology is to disclose ESG details following reporting standards and frameworks such as GRI, SASB, CDP, TCFD and IFRS. The more data available, the less these firms will need to rely on third-party sources and incomplete information. In a sense, disclosures help you tell your story versus letting others tell it for you.
The second action to take is to identify the factors individual ratings firms consider and how much power you have to dispute a published score. Remember, you won’t get the full calculation criteria, but most firms will reveal the categories they score.
The well-established ratings
Given the abundance of ESG scoring agencies available, and the comprehensive information required to assess each one deeply, the following list aims to provide concise yet informative details pertaining to some of the most well-known scorers in the ESG field. Let’s delve in.
As of June 2020, MSCI rates 8,500 companies and over 680,000 equity and fixed income securities worldwide, collecting thousands of data points on each. MSCI ESG ratings are designed to measure a company’s long-term, financially relevant ESG risks.
The ratings are assigned on a scale resembling bond ratings, ranging from CCC (weakest) to AAA (strongest). The scores are derived by evaluating performance across 33 key issues encompassing environmental, social and governance pillars. Then, the scorer adjusts to account for industry-specific considerations to generate the final score. Industry benchmark calibrations occur at least annually with occasional interim changes.
Although scorers typically update company ratings annually, MSCI’s research team continuously monitors corporate news for controversies and governance events that may affect an entity’s score. When such events occur, and analysts decide a score update is necessary, they will usually make the change within a week. Companies are free to dispute a rating directly with MSCI. If there is a disagreement, MSCI will review the case and either adjust the score or reject changes. Importantly, MSCI will only take publicly available information into consideration for scoring without exception.
The MSCI ESG Research ratings form the basis of MSCI’s Equity and Fixed Income Indexes and are used by over 1,400 investors. A good rating here will influence a company’s potential to be part of an MSCI index and a potentially higher volume of investors. Companies can easily find their MSCI ESG rating by searching MSCI’s website.
Sustainalytics & Morningstar
With roots dating back to the early 1990s, Sustainalytics was one of the first firms to rate companies based on their sustainability postures and to benchmark them against their industry peers for relevant comparison. In 2016, Morningstar launched ESG scores for investment portfolios derived from Sustainalytics’ ratings before acquiring Sustainalytics four years later. Today, Sustainalytics rates ESG risk for over 20,000 companies.
The Sustainalytics ESG Risk Ratings scale provides a clear measure of a company’s ESG risk. The scale ranges from zero (negligible ESG risk) to 100 (indicating severe risk), with scores above 40 indicating severe ESG risk. While scores over 60 indicate high ESG risk, they are uncommon. To determine a company’s score, Sustainalytics examines a company’s full exposure to ESG risks based on its subindustry and unique company factors. Next, it gauges how well company management mitigates that risk. The final score reflects the total unmanaged risk. Remember that Sustainalytics Risk Ratings are meant to compare peers. Consequently, a score that looks relatively high on its own could also reflect an industry with a high degree of unmanageable risk.
Sustainalytics also produces Corporate Governance Ratings for more than 4,200 companies with a rating scale of 100 (the best) and zero (the worst).
Using data from Sustainalytics can help companies identify their levels of risk as related to their industry peers to leverage their leadership or improve their risk management. Sustainalytics ESG Risk Ratings are available on the Sustainalytics website or through data feeds to investment intelligence platforms, but access to the full report details comes at additional cost.
S&P Global & DJSI
Unlike most other scorers on this list, S&P Global involves the companies it rates in the scoring process through the S&P Global Corporate Sustainability Assessment (CSA), an approximately 130-question survey that includes industry criteria and asks companies to provide evidence about their claims. S&P collects up to 1,000 other data points on each company before deciding its score from 1 to 100, with 100 being the best. S&P also monitors news for material controversies that could affect a firm’s reputation. If they find fault with a company, the firm has the opportunity to respond to provide verifiable countervailing evidence and remediation plans to S&P.
S&P Global ESG Scores are major underlying factors for the Dow Jones Sustainability Indices (DJSI). DJSI are a series of indexes that include companies with the highest ESG ratings in the world or in their region. Current iterations of the index are DJSI World, DJSI North America and United States, DJSI Europe and Eurozone, DJSI Asia Pacific and DJSI Korea. The DJSI indexes are the longest-running global sustainability benchmarks and are important markers on the performance of ESG investing versus other methods. S&P Global ESG Scores can be found on their website with high-level analysis; full details are available on request.
Founded in 1985 as Institutional Shareholders Services, ISS is a proxy advisory firm that started evaluating companies, funds and countries ESG performances early in its history to account for investors’ material interest in covered topics. ISS collects data from online reporting and corporate filings along with disclosures to national regulatory authorities. The rest of the information is filled in by media sources (including social media), government agencies and non-government organizations to provide the final multi-dimensional scores.
ISS works with the companies it rates, informing them ahead of a change to their rating and holding a comprehensive dialog every two to three years. When evaluating a rating, companies can inform ISS of non-material and non-public information to provide context or supplement conclusions ISS has made for ratings. Even though ISS will accept some non-public information, its policy is strict about rejecting information that would likely affect a security price if publicly disclosed.
The main ISS score is a a letter grade from A-plus to D-minus. Other ratings include a Governance QualityScore, an SDG Impact Rating (related to the United Nations Sustainable Development Goals) and a Cyber Risk Score. ISS will grade an organization as "Prime," meaning it exceeds a sector-specific threshold for fulfilling ambitious absolute performance requirements related to peers in its industry, or "Not Prime" meaning it does not achieve this threshold. The Prime threshold is C-plus for most industries, B-minus for high ESG risk industries and C for industries with lower risk profiles.
With ISS being one of the most trusted global advisory firms with about 3,400 clients including many top institutional investors, a strong rating can help influence investor sentiment. Companies can find the ISS scores freely available on the ISS website and should contact them directly for more depth on the rationales behind the scores.
In the second installment of this series, we will discuss ESG Score Calculations, providing further commentary about the newcomers to the market, alternative methodologies and critical viewpoints into the ever-evolving field of ESG scoring methodologies.