ESG scores are a measure of the sustainability of an investment. For instance, ESG scores can be used to determine if an investment is sustainable for its investors, employees, shareholders and the environment. Although there are numerous ESG frameworks, they are all roughly based on five different aspects: social responsibility, environmental responsibility, economic performance, governance practices and citizenship. Each company will require a different set of variables to be measure. For example, an pharmaceutical company will have different measures of reporting criteria as a food retailer and distributor or companies in the oil & gas sectors.
The idea behind this scoring system is that companies which have higher ESG scores are more likely to provide better returns on investments because they are less likely to suffer from any negative impacts in these areas. There are also exhibiting their commitment to sustainability.
- Why ESG, why now?
- Why is an ESG score important?
- What does it mean for investors?
- How to explain an ESG score?
- How is an ESG score measured?
- How does an ESG rating work?
- How can you improve an ESG score?
- What are examples of companies which have improved their ESG scores?
- 3 common ESG metrics?
- How can I find a company’s ESG score?
- How can I learn about ESG scores?
- Why is it important for businesses?
- How do I read an ESG score?
- How does a company get an ESG score?
- How is the esg score of an investment portfolio calculated?
- In conclusion on ESG risks and ESG ratings
- Caveats, disclaimers & corporate governance
Why ESG, why now?
The recent pandemic has made more people consider the long term effects of their investments. And with the increasing intensity and duration of storms, wildfires and weather events, it has become increasingly important to take sustainability and the company’s environmental impact seriously. The Paris Agreement, which was ratified in 2020, acknowledged the importance of improved transparency and reporting methods for all countries to use when measuring their contributions towards mitigating global climate change. The agreement was also focussed on forcing companies to adapt to sustainable practices.
Why is an ESG score important?
An ESG score can be used by investors to judge a company’s environmental and social performance. There has been a trending for investors to pay attention to the ESG metrics of companies they invest in – this includes many high profile investors, such as Bill Gates and Michael Bloomberg.
What does it mean for investors?
ESG has become a hot topic in the investment world, with many companies jumping on board to make sure they are able to measure all aspects of what makes a company sustainable. The importance of ESG scoring has been recognized around the world, including the World Bank. They argued that investors needed to look at long-term viability while making their investment choices. They stated that “It is essential that banks and other financial institutions develop a thorough understanding of ESG risks and opportunities in order to provide sustainable, socially friendly services”.
How to explain an ESG score?
A company’s ESG score can range anywhere from zero (which means that it has no positive or negative impact) up to 100% (which would indicate perfect sustainability). It should also be noted that some countries have implemented ESG (SEC) score requirements for companies. For example, Norway requires all oil and gas companies which operate within the country to have a minimum of a 40% ESG score in order to gain a license.
How is an ESG score measured?
- Social Responsibility: This section focuses on how a company treats its employees and their ability to work freely without harassment or undue pressure from other employees. The focus is not on a company’s charitable giving, but rather how it treats its own employees so as to avoid lawsuits or other problems from arising from conditions at work.
- Environmental Responsibility: This section focuses more on the environmental impacts of a business and can include things such as efficiency in energy use, pollution control practices, water related issues and recycling programs.
- Economic Performance: This section looks at the financial health of a company and its ability to ensure that it can be successful both in terms of investments and creating jobs. A high score here shows that the company is financially stable and will not suffer from major changes in its economic situation.
- Governance Practices: This section examines how a business is run and whether it is likely to be well-run. It includes things such as how the company manages its employees, the quality of decisions that are made and how much trust its investors have in management.
- Citizenship: This section focuses on what sort of investments a company makes elsewhere in the world and affects people other than its own employees or shareholders. It includes how a company treats the stakeholders. This includes the community where it is based, if any of its business locations have been involved in negative incidents and whether they are likely to cause problems in these areas.
In order to calculate an ESG score for a company, each of these five sections will be given a rating from one to 100. These ratings will then be added together to provide the final score for the company.
How does an ESG rating work?
Companies are rated on a scale of zero to 100, with zero being the lowest possible score and 100 being the highest. When you go to invest in securities, you would likely receive an ESG rating before doing so to give yourself an idea of just how sustainable this company is.
How can you improve an ESG score?
To improve an ESG score, an organization might start by looking at their supply chain. The supply chain can have a large influence over the ESG score because it makes up the immediate actions of organizations. Any business which has an outsourced supply chain will want to consider how to monitor for possible poor practices taking place within it.
A business can also improve their ESG score by following certain guidelines, such as only using eco-friendly products in the production of goods or reducing the amount of energy the business uses in the production of good or provision of services.
An organization should also create policies and standards which go beyond what is required by law, within their given industry. The ESG score can be improved by keeping up to date with evolving standards and expectations. Every score is a reflection of the policies in place, so the easier it is for employees to follow them, the higher the score will be.
An organization can also make changes to their management systems. The ESGL score is a reflection of how well an organization manages its operations, so if they have any weak points, these should be prioritized and addressed.
ESG score improvement is never a small task, but it is possible to make changes within the organization or from their suppliers that will positively impact a company’s ESG score over time. Small steps lead to big results.
What are examples of companies which have improved their ESG scores?
Examples of companies that have improved their ESG score are Coca-Cola, Walmart and Apple Computers.
Coca-Cola has is one of the most well known ESG score improvers. They took steps to reduce their carbon footprint by producing bottles that are 30% lighter than standard bottles.
Walmart improved its ESG score by taking steps to reduce greenhouse gas emissions across its supply chain.
Apple Computers improved its ESG score by reducing toxic flim and other harmful chemicals from the production of it products, as well as looking at their own environmental impact.
Another real world example is that some investors are moving away from investing in companies which do not report on how many of their employees are women. You can find out more about these types of changes by reading news articles or checking the company website for updates on policies.
3 common ESG metrics?
Some metrics used in ESG scores include greenhouse gas emissions per revenue, CEO pay ratio, and total revenue growth per greenhouse gas emissions. What is each of those?
- Greenhouse gas emissions per revenue: also known as carbon intensity, this shows how much carbon dioxide a business emits for every unit of revenue generated. This metric refers to the production of goods and services rather than the use of services (for example, a bank does not emit greenhouse gases for their regular banking activities).
- CEO pay ratio: also known as income inequality, this compares the compensation of a company’s CEO to that of the median worker. The ratio is calculated by dividing the CEO’s annual total remuneration (salary and benefits) by the median remuneration of all employees.
- Total revenue growth per greenhouse gas emissions: this metric shows how much the company’s revenue has grown by for every unit of carbon dioxide emitted in one year. This can be useful if a business is trying to show that they are reducing their environmental impact.
How can I find a company’s ESG score?
A company’s ESG score can be found on company’s websites, social media platforms like LinkedIn or in ESG ratings. These can be found on websites such as Calvert, MSCI, and Sustainalytics.
How can I learn about ESG scores?
You can look up company ESG ratings on S&P Global, Bloomberg Terminal, Calvert, MSCI, or Sustainalytics to see how companies are performing relative to their competitors. These sites will also give you information about what each of the metrics mean.
Why is it important for businesses?
Businesses should care about their impact on society because customers are increasingly expecting businesses to be socially responsible. A company’s reputation can also be affected by the actions of its suppliers, so supplier and supply chain audits are becoming increasingly popular for this reason.
If one company has a poor ESG score, it will find it difficult to compete with companies who have better scores. For example, if an energy company has a bad ESG score they may lose out to other energy companies who are perceived as having better ESG scores. This may also affect grants and R&D funding which they are eligible for, as well as loans.
How do I read an ESG score?
An ESG score is very simple, because it will be a number between 1 and 100. The higher a company’s ESG score, the better they are performing in that area. If a company has an ESG score of 49, for example, this means their performance is only slightly worse than average at that point in time. If their ESG score is above 50 it suggests they are doing better than others in that industry or area. If a company has an ESG score of 1 it means they are doing worse than others in that industry and area. An ESG score is compared to a benchmark. Benchmarks vary depending on the sector and area you are researching (for example, an aerospace sector benchmark).
How does a company get an ESG score?
To get an ESG score, a company must do several things. First, the company must decide which metrics are important to them for their ESG score. Next, they will set policies and goals for each of these metrics based on the following: what they want to achieve, how many years it will take to make a change, and a quantitative target (for example, a reduction in greenhouse gas emissions of 5% per year). Then, they need to track their progress against these metrics. The final piece is the reporting of this information to a 3rd party with no vested interest in the company. This will provide evidence to investors, regulators, and other stakeholders that their audit is true.
How is the esg score of an investment portfolio calculated?
The ESG score of an investment portfolio is calculated using an investor-centric financial analysis. The metrics used to calculate the score vary depending on the company that sells the ESG scoring calculation, but one of the most popular metrics that is used in these calculations is Sustainalytics’ Corporate Sustainability Assessment (CSA) Score, which provides information about how much companies are putting their investments towards aims that protect and improve our planet and societies. Using this information, it is possible to analyze the environmental and social policy of a company and determine how likely it is that they will be able to maintain or increase their financial value using these policies in the future.
In conclusion on ESG risks and ESG ratings
ESG scores are a measure of the sustainability of an investment and the measure of a company on their environmental and social efforts. For instance, ESG scores can be used to determine if an investment is sustainable for its investors, employees, stakeholders, shareholders and the environment. Although there are numerous ESG frameworks, they are all roughly based on five different aspects: social responsibility, environmental responsibility, economic performance, governance practices and citizenship. These 5 factors factors will determine whether we live in a sustainable future. And with the rise in personal ESG scoring, it will only increase until we are all living sustainably.
Caveats, disclaimers & corporate governance
At ESG | The Report, we believe that we can help make the world a more sustainable place through the power of education. We have covered many topics in this article and want to be clear that any reference to, or mention of responsible investment and financial management of your assets, a company’s business relationships vs the investment process, carbon emissions and investment strategies or socially responsible investing in the context of this article is purely for informational purposes and not to be misconstrued as investment or any other legal advice or an endorsement of any particular company or service. We highly recommend that investors use a financial advisor, certified financial planner or investment professional before entering the markets.
Thank you for reading, and we hope that you found this article useful in your quest to understand ESG and sustainable business practices. We look forward to building a sustainable world with you.
Research & Curation
Dean Emerick is a curator on sustainability issues with ESG The Report, an online resource for professionals focusing on ESG principles. Their primary goal is to provide resources to help middle market companies, SMEs and SMBs transition to a more sustainable future.