What is an ESG score and how does it matter?
How eco-conscious is your business, and how well are you interacting with your community? This question might be a bit hard to answer.
Today, simply reducing, reusing, and recycling isn’t enough when it comes to reducing your impact on the environment. Neither is a simple mission statement when it comes to social impact. In response to concerns about climate change and social issues, today’s consumers value environmental responsibility, sustainability, and awareness from businesses and corporations.
For example, a recent study conducted by McKinsey reveals that more than 60% of the surveyed consumers stated that they would be willing to pay more for sustainably-packaged products. It also mentions how a complementary study conducted by NielsenIQ discovered that living an environmental lifestyle is important to 78% of U.S. consumers.
You might have a general idea of where you stand when it comes to your organization’s sustainability and communal initiatives, but what if there was a better, more official way to measure your environmental and societal impact? To figure out where they stand when it comes to sustainability efforts, many organizations are turning to ESG data.
Before you write off ESG scores as yet another pile of corporate governance paperwork to be added to your regularly scheduled filings and annual reporting, keep in mind that your organization’s ESG metrics are a crucial part of your organization’s performance. When understood and leveraged correctly, your organization’s ESG performance can boost your business.
In this guide, we’ll cover the key issues of ESG scores, including their scoring system and methodology. Also, you’ll learn how to make ESG ratings work for your business when we discuss how an organization’s ESG disclosure affects its investment decisions, stakeholder engagement, and risk management.
What’s an ESG score?
An ESG score is a rating system used to evaluate a company’s efforts within environmental, social, and governance factors. The ESG scoring system is a way to quantify the hard numbers of a factor as subjective as impact when it comes to sustainability, risk-management, and societal implications.
ESG ratings are a way for consumers, stakeholders, and investors to gauge a company’s performance outside of the available profit reports, marketing language, and general consumer bias.
What’s a good ESG score?
Because there isn’t a universal ESG rating system, there’s no set ESG score that can easily compare companies. ESG scores fall into three broad families:
- Issue-specific ESG scores: These ESG scores define an organization’s ESG performance based on a single issue such as a financial factor.
- Category-specific ESG scores: This type of ESG score weighs multiple ESG factors within one of the general environmental, social, governance concerns. This scoring system chooses one of these three areas to focus on, such as environmental issues, and gathers enough information to get a sense of the company’s impact within that category.
- General ESG scores: These ESG ratings pull a wide variety of data across all three factors to provide an overall ranking. The MSCI and Bloomberg scores are examples of general ESG rankings.
Usually, ESG scores are valued on a scale from 0-100, with 100 being the best. But the ESG rating agency, MSCI, stands out because it uses a seven-point scale from 0.000-10.000 that correlates to a letter rating, where CC is the worst (laggard, 0.000-2.856), BBB is the middle of the pack (average, 2.857-5.713), and AAA is the best (leader, 5.714-10.000).
How to get your ESG score?
There’s no single organization that issues ESG scores. Companies seeking ESG analysis can choose from multiple ESG rating agencies that analyze organizations’ ESG performance.
Calculating your ESG
The exact calculations of the ESG scoring methodology can change depending on the criteria, benchmarks, and guidelines used by individual ESG rating agencies.
ESG methodology involves gathering as much information as possible about an organization’s impact within the environmental, social, governance parameters.
This data can be taken from public records, such as the organization’s past ESG reports and research. ESG rating agencies typically rely on ESG frameworks to guide their metrics.
Popular ESG frameworks include:
- IFRS Sustainability Disclosure Standards
- SASB Standards
- CDSB Framework
- GRI Standards
- Task Force on Climate-Related Financial Disclosures
- United Nations Global Compact
- Workforce Disclosure Initiative
In addition to these metrics, ESG scoring providers will also use self-reported data from the company.
Once all of the necessary scoring information is gathered, ESG issuers will then plug this data into their rating algorithms. The information is valued based on data points to generate a rating.
Popular ESG rating agencies
Since each ESG rating agency has its own metrics and scoring system, their resulting ESG scores have different applications. Below, find a list of the most common ESG rating agencies and their uses.
- MSCI: The MSCI ESG ratings use an industry-specific scoring methodology and is one of the top ESG score issuers.
- Bloomberg ESG Data: In addition to conducting their own data collection, the Bloomberg scoring system relies on data points from MSCI and Sustainalytics.
- Fitch Ratings: This issuer uses its own metrics for ESG ratings and relates its ESG score to credit ratings.
- ISS ESG: The Institutional Shareholder Services (ISS) uses a financial scoring system framework.
- Moody’s: This provider is known within the finance industry for its bond rating system.
- Refinitiv: The Refinitiv ESG score, which is determined by using public reports, is useful for companies engaging in a global reporting initiative.
- RepRisk: This AI-powered ESG issuer uses machine learning in addition to ESG analysis professionals and primarily calculates ESG risk.
- S&P Global Corporate Sustainability Assessment: The S&P Global ESG score provider relies on a questionnaire that covers industry-specific and general market data points. The Corporate Sustainability Assessment’s analysis is incorporated in the Dow Jones Sustainability Index and its ESG score ranking.
- Sustainalytics: Another provider that primarily calculates ESG risk. Sustainalytics uses its material ESG issues (MEIs) to generate an ESG score.
Choosing an ESG rating agency
With so many ESG rating agencies and possible scoring system frameworks to use, the process of finding the right ESG scoring provider can be overwhelming. When deciding which ESG rating agency to use, consider these questions:
- How much self-reported data does your company have available?
- How much publicly-reported data is accessible for your company?
- What ESG rating agency is the go-to in your industry?
- If you’re looking to compare your ESG score with your competitors, which provider did they use?
- What information, metrics, and ESG factors are going to be the most useful for your stakeholders?
- Are there any regulations or corporate governance that influences what type of rating system you need?
What factors contribute to your ESG score?
The ESG score goes beyond sustainability to provide an outside-in evaluation of a company. As its acronym suggests, there are three main categories considered in an ESG score: environmental, social, and governance. Some of the metrics within these categories are industry-specific, while others are applicable across the entire market as in the case of carbon emissions, business ethics, and labor practices.
The environmental and sustainability ESG issues include not just how the organization impacts the natural world but its plans for continued improvement. Criteria within a company’s environmental impact include metrics such as carbon emissions, climate change vulnerability, waste management, water sourcing and pollution, land use, and packaging materials.
The social responsibility considerations within an ESG score consider the company’s impact on its surrounding society, both within and outside of the office. This measurement encompasses human rights, human resource practices, employee satisfaction, worker safety, stakeholder engagement, and positive impacts on – or controversies with – the local community.
The ESG score’s evaluation of corporate governance looks at the business ethics within a corporation and its individual responsibility. These criteria turn a critical eye on a company’s diversity and inclusion initiatives (DEI), executive compensation, tax payments, and documentation transparency.
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What are the limitations of ESG scores?
While useful, there are a few drawbacks to the ESG scoring system. Before choosing your ESG rating agency, consider these limitations:
- No standardization: A core use of the ESG score is comparison with other companies, and yet there’s no set methodology for calculating ESG rankings.
- Self-reported data: Because companies can opt to use their own data, there’s a possibility that this information is biased and therefore skews the final ESG score in their favor.
- Transparency: Each ESG rating agency relies on its own metrics and competes with other ESG score providers. As a result, most of these providers aren’t open about their calculations or metrics.
- Scope: While ESG reporting is designed to give a qualitative number to an organization’s sustainability efforts, it can’t fully incorporate every single ESG factor that is a part of the organization’s environmental, social, governance impact.
Why your ESG score matters?
A company’s ESG score is more than a measure of its ecological footprint. It encompasses human resource procedures, employee satisfaction, and business ethics. Societal and environmental issues are becoming increasingly important to stakeholders, investors, and consumers. For example, a company’s support of LGBTQ+ issues or the Black Lives Matter movement can sway both public opinion and employee support.
In other words, an ESG score is an evaluation of how the entire company is actually performing outside of its mission, marketing language, and profit reporting. This awareness is important when it comes to risk management of economic and social factors, and forecasting an organization’s long-term performance.
Investment and risk management
A company’s ESG performance is especially weighed in investment decisions as a benchmark for investors and stakeholders to gauge risk. Investment decisions are rarely made impulsively, especially when there’s a large amount of capital at stake. If a company has a low ESG score – or has neglected to get one – an investor could be swayed towards investing that capital in a competitor. Additionally, if a company’s ESG score damages its reputation, stakeholders might decide to pull out of the company and turn their attention elsewhere.
A high ESG score shows that a company is actively looking toward the future and investing in its initiatives for growth. These organizations are evaluating how to make the largest impact in as many areas as possible, which positively impacts their brand awareness and profit margins.
Comparison and competitive advantage
Despite their differences in metrics and scales, ESG rankings allow consumers, investors, and stakeholders to compare competing organizations. It also allows companies to gauge their performance in relation to their competitors and make the necessary adjustments to gain the upper hand.
Builds customer loyalty
ESG disclosure not only helps a company’s bottom line but makes them more attractive to consumers who share the same values.
The fact that consumers are seeking sustainability and are willing to pay more for sustainable products is a great incentive for companies to publicize their ESG disclosure. However, refrain from over-exaggerating your company’s efforts toward sustainability and climate change. This over-exaggeration is known as greenwashing, and it has landed some major companies in legal trouble.
When companies are honest and transparent about their ESG initiatives, like-minded consumers are more likely to flock to them over their competitors. This builds a relationship and loyalty that goes beyond general branding and marketing.
Reasons to invest in an ESG score
- Benchmarks of success: An ESG score provides validation of environmental, social, and governance initiatives. It helps organizations measure their success and progress towards goals, as well as provides benchmarks for performance within the industry.
- Comparison: ESG scores allow businesses to measure their outcomes against competitors and see in which areas they need to improve their strategies.
- Investors: High ESG scores are attractive to investors and can give the company a competitive edge within its industry.
- Risk management: ESG scores highlight concerns or deficiencies that could negatively impact the company’s future long-term success.
How to keep up with the evolving landscape of ESG?
With so many different ESG factors that contribute to a company’s success, it’s no wonder that there’s no universal consensus about how the ESG score should be calculated. Despite its complexity, an ESG score is an invaluable tool for businesses to evaluate their performance, manage risk, attract investors and consumers, and strategize future initiatives.
An ESG score provides awareness not just of your company’s current competitive positioning and impact, but how you can get ahead and stay there.