Over the past few years, as we have become more aware of both our impact on the planet and the impact of a changing planet on us, there has been enormous growth in the market for investments which align with the green, social and sustainable values of both businesses and individuals.
But it isn’t always easy to determine what a business is doing to address the non-financial risks that it may face as a result of environmental, social and governance (ESG) factors. To help investors (and others) navigate the potential sustainability risks to business performance there is a growing number of commercial and non-profit organisations that will provide them with an ESG rating.
What is an ESG rating?
According to Greenbiz, an ESG rating is an assessment of "how corporate commitments, performance, business models and structures align with sustainability goals". In essence, it is a score which demonstrates, at a glance, how well a business is managing risks arising from issues such as climate change, pollution and waste, management of its work force, business ethics and board diversity that may have a financial impact on it.
Who can be rated?
Any business can obtain an ESG rating at any time and it may, in certain circumstances, be required to obtain an ESG rating. For example, if a business is looking to issue a green, social, sustainability or sustainability-linked bond, it can have (or may be required to have) different aspects of its offering evaluated by a ratings agency.
What are the benefits of a rating?
For many investors being able to obtain an objective and easily understandable measure of a company's exposure to, and management of, its long-term environmental, social and governance risks helps guide their decision making and, in the case of funds and asset managers, their investment strategies. An ESG rating can be used to supplement financial analysis, as a screen if you want to try and invest in companies which are 'good corporate citizens' or as a potential indicator of problems if the ESG rating of a company which they have invested in changes.
An ESG rating may also determine such things as a business's cost of capital, whether or not its shares will be included in an ESG-themed fund, in an investment portfolio or an investment product or on lists of most sustainable companies.
ESG ratings may also be used by job seekers, customers and others to assess business relationships and by the companies themselves when undertaking a SWOT analysis as they seek to ensure that their strategy takes account of people and planet as well as generating a profit.
Who provides ratings?
ESG ratings are provided by companies and non-profit organisations. Each of the firms which provide ESG ratings assess thousands of businesses across a wide range of topics in order to determine a company's ESG 'score'. Moody's and Fitch who are both well known for providing credit ratings, each have an ESG ratings division.Other providers include ISS ESG, MSCI, Sustainalytics, Bloomberg, and Vigeo Eiris. S&P also provide assessments of a business's ESG matters but in August 2023 elected to stop providing a score (from 1 to 5) of a company's exposure to ESG risks.
What are the challenges?
One of the main challenges with ESG ratings is that there is no clear or common methodology which is applied by the ratings providers to determine the ratings or scores which they give. Some organisations will base their ratings only on data that is publicly available, others will combine publicly available data with responses to, in some cases extremely detailed, questionnaires.
Each provider will have its own set of topics, issues or criteria that it assesses and they will usually assign different weights to those topics, issues or criteria depending on, for example, the sector in which the business operates, the potential impact of the topic or issue on the business and how soon it will impact the business. They will also score differently with some giving, for example, high performing companies a low score and others a high score.
The lack of transparency around the various proprietary methodologies used to determine ratings coupled with the lack of clarity and alignment around definitions or what these products are intending to measure and the difficulties which companies being rated may face in changing or amending information which is outdated, incomplete or wrong has resulted in increased scrutiny from regulators around the world and coupled with a number of high profile instances of companies with very good ESG ratings proving to be anything but good corporate citizens as well as the high degree of risk for misuse and misunderstanding of ESG ratings resulting in harm to consumers means it is only a matter of time before ESG ratings providers are brought within the regulatory ambit.
How we can help
If your business needs or wishes to obtain an EG rating, our team of highly skilled teams of specialists in areas such as green, social and sustainable finance, impact investment and blended finance, governance, employment and corporate can assist you with a review of the environmental, social and governance risks to our business and help you to develop policies and procedures to mitigate those risks.
Strategic review
Understanding your business and the sector in which you operate is key to understanding what your organisation needs to do in order to identify and address the material ESG risks faced by your business. We will get to know you and your team and work with you to assess what new policies and procedures may be needed and which existing ones need to be changed.
What's involved
Our experts will work with you to help you assess what new policies and procedures may be needed to address the material ESG risks which your business may face. You know your business best and we can help shape the policies and procedures that will work for you. We can provide training on areas of interest to your executive team/board members.
What it will help you to achieve
Having identified the material ESG risks for your business, developing a robust set of policies and processes to address those risks will help you demonstrate your commitment to managing and mitigating those risks to your investors, ratings agencies and others.