Corporate sustainability and social responsibility have become major factors when evaluating, managing and growing businesses across all industries. Due to this shift, investors and internal decision-makers require a process for evaluating how well a particular organization is meeting these expectations – or failing to do so. Enter the Environmental, Social, and Governance (ESG) rating system.
So, what exactly is an ESG rating? Put simply, it is a multi-factor measurement of how an organization is performing in the key issues of environmental sustainability, social impact and equity, and internal governance. These evaluations typically appear in two forms - a triple-A rating format and 0-100 score format. The triple-A rating ranges from CCC (lagging behind industry standards) to AAA (leading the industry) and is awarded relative to the ratings of a company's peers. The 0-100 score format simply states that zero represents no risk, with increasing risk as the score elevates and an understanding of significant risk posed to a business for a score surpassing 40. These ratings are then used, for example, by investors to determine what organizations present the least risk to their investment. Conversely, a CEO may use these scores in order to assess internal risk and take proactive measures to protect the business, thereby attracting investors. According to the MCSI ESG Ratings Methodology, there are four main questions the ratings model seeks to answer.
- What are the most significant ESG risks and opportunities facing a company and its industry?
- How exposed is the company to those key risks and/or opportunities?
- How well is the company managing key risks and opportunities?
- What is the overall picture for the company and how does it compare to its global industry peers?
The answers to these questions are factored into a model that assigns certain levels of importance to each piece of information, as seen below:
This evaluation results in an ESG rating that will inform a plethora of business dealings and financial decisions across the globe. For example, numerous funds have been founded by some of the largest firms in the world, which are specifically geared toward ESG investing and slated to hit $1 trillion in assets by 2030. Additionally, research has uncovered a positive relationship between ESG ratings and financial returns.
It is now clear that investing in a good ESG rating can make your company more appealing to investors, but there are other benefits to consider as well. The process itself provides an outside review of your company’s image and allows you to check the effectiveness of your current initiatives. Additionally, the actions and policies you enact may provide the foundations for future business development and growth.
There are currently around 120 agencies that provide ESG ratings, such as MCSI, Sustainalytics, RepRisk, Robeco and ISS. Due to the sheer amount of scoring bodies, the sector has yet to be standardized – until now. ESG Book aims to disrupt the highly profitable sustainability sector by offering free “transparent, comparable ESG data” to connect investors with low-risk companies and analyze this data for a fee. Regulatory and governmental agencies have recently focused on ESG rating companies as greenwashing and misleading claims have become more common - an unfortunate by-product of monetizing sustainability in a world combatting climate change.
So, how do you improve your ESG rating?
The environmental portion of the score can be improved through a variety of initiatives within your company’s operations, such as ensuring that the impact of your supply chain and material sourcing or production is reduced or offset. You may offset your impact by way of purchasing carbon credits or contributing a portion of your profits to sustainability efforts. In many cases, becoming more sustainable can result in financial benefits for your company via improved efficiency, monetary savings, and tax incentives. For example, investing in energy saving technology such as fleet electrification can reduce your fuel and maintenance costs year after year, and potentially result in the awarding of usable, sellable and tradable carbon credits if verified by an approved regulatory body. Any measurable positive impact to an organization’s footprint can result in a better rating.
An organization may boost itself in the social arena by investing in the health and safety of its workforce. You might pursue greater diversity and inclusion at all levels of your company, move to educate customers and employees on social issues, or participate in programs that contribute to social equity. Ensuring that all employees have access to nutrition, healthcare and financial support are all important aspects of social equity and would thereby increase your score – or at least not reduce it.
Lastly, you may better your company’s governance by developing policies for addressing greater employee engagement with executives, greater transparency of internal operations, or instituting clear limits on executive payouts compared to your company’s average salary. Tax transparency and ethical business practices play a significant role as well.
See below for a chart outlining the key issue hierarchy.
These three key issues are weighted based on industry impact and the amount of time the risk or opportunity could take to materialize. Because of this, ESG scores are very difficult to predict and the best course of action to take is to simply take action now. With the popularity and importance of ESG ratings rising, there is no better time to have your organization appraised and begin improving your current rating.