ESG scores are set by companies themselves. ESG scores measure the degree to which environmental, social and governance risks and opportunities are integrated into an organization’s strategy and business operations. It is not a score that is determined by any regulatory agency, but rather it is set by the company itself through its long-term vision, policies, plans, goals and objectives. But they are measured by companies including MSCI, Sustainalytics, Gartner, Forrester Research, and the Ernst & Young OCEAN™ rating system to determine where they stand in terms of their ESG risks and opportunities. This allows companies to receive feedback on how investors view these factors when they consider investing in them, but ESG scores are not used by any regulatory agency like the SEC, but an investor can also use these factors when considering investing in a company.
- Who determines ESG ratings?
- Who is MSCI?
- What does MSCI ESG stand for?
- How does MSCI measure ESG factors?
- What is Sustainalytics?
- What does Sustainalytics ESG stand for?
- How does Sustainalytics measure ESG factors?
- What is Gartner?
- What is Forrester?
- What is the OCEAN™ rating system?
- How are ESG scores determined?
- How can these scores be used to help the company’s goals?
- What are some examples of ESG scores?
- What is the interest of Governments with ESG scores?
- What is Responsible Investment?
- What are the Challenges Facing the Development of Standard ESG Scoring?
- How to set your own ESG score
- What did we learn today?
- Caveats, disclaimers & ESG performance
Who determines ESG ratings?
It is not a score that is determined by any regulatory agency, but rather it is set by the company itself through its long-term vision, policies, plans, goals and objectives. The company also determines the ESG rating through third party assessments like MSCI, Sustainalytics, Gartner, Forrester Research, and the Ernst & Young OCEAN™ rating system to determine where they stand in terms of their ESG risks and opportunities.
Who is MSCI?
The MSCI is a global provider of classification and research that provides investable indices, calculators and software tools to institutional investors all around the world. They offer many different types of benchmarks, including those for project analysis, governance, sustainability, those that measure economic development and much more.
What does MSCI ESG stand for?
The MSCI is a global provider of classification and research that offers many different types of benchmarks, including those for project analysis, governance, sustainability, and much more. Some of the commonly used indexes are the MSCI KLD 400 Social Index (ESG), the MSCI ACWI ex-USA Index (ESG-US), the MSCI Emerging Markets IMI Index (ESG-EM), and other indices. So, in short the MSCI is a global provider of indices.
How does MSCI measure ESG factors?
The MSCI scores companies to determine their ESG factors based on the OBSI® (Outcome-based Sustainability Investment) platform, which takes into account environmental, social and governance issues that are then translated into indices. Their methodology is based on five pillars including governance, strategy, risk management, ESG information and integration. Governance is the ability of a company to create value in its industry by setting standards based on best practices. Their ESG Risk Management framework assesses the risks that companies face like climate change or corruption.
Strategy refers to how companies are performing in light of environmental and business risks. It also takes into consideration the degree to which companies are integrating ESG risks in their strategies, like through climate change or water risk management. Risk Management deals with the protection that is available with respect to potential adverse effects on an organization’s financial performance. The ESG information pillar has two components: transparency and quality of ESG information. Integration refers to the degree to which ESG risks are being integrated into portfolio companies’ strategic and operating decisions.
What is Sustainalytics?
Sustainalytics is a company that provides sustainability ratings, benchmarking tools, research data, and investment products to organizations across the globe. They have access to unique proprietary data sets that are used for sustainability ratings.
What does Sustainalytics ESG stand for?
Sustainalytics offers many services such as Fundamental Review, which looks at Corporate Strategy:
- Governance & Structure, for material issues in the company’s business model
- Engagement Services where they work with companies to help them communicate with shareholders on specific company issues and
- Performance Analytics, which uses information in the company’s annual report to determine how sustainable they have been.
Sustainalytics is a provider of ESG ratings, research and tools for institutional investors like grant makers, endowments, pension funds and family offices. They publish research reports that examine the material ESG issues that come up for 10 Russell 1000 companies every year and how it relates to their performance. Their methodologies include both quantitative and qualitative assessments.
How does Sustainalytics measure ESG factors?
Sustainalytics scores companies using a sustainability performance model that is based on the Global Reporting Initiatives (GRI) G3 Guidelines to determine their scores. The model assesses three areas: governance, strategy and risk management. They use the same sectors as MSCI ESG, so the companies they rate will be in those exact same sectors as determined through MSCI ESG research.
They also grade companies based on specific GRI guidelines and areas of focus, including: climate change, environmental impact, human rights and labor practices, anti-corruption and bribery concerns and product safety.
What is Gartner?
Gartner is an information technology research and advisory company that provides analytical tools for businesses to help them make decisions about IT. Their areas of focus include cloud computing, media and entertainment, security, customer experience, global strategy services and finance/accounting. They also provide consulting services for companies to determine risk.
In 2005, Gartner started a program called the Critical Capabilities for Social Business Governance. The program provides guidance to business leaders on how they can make decisions based on social-related aspects which affect their businesses in different ways.
Sustainability is a subset of this program that deals with determining the level of engagement that companies have towards developing a sustainable business model. Their methodology is based on five sub-methodologies: awareness, commitment, capacity, management readiness and alignment.
What is Forrester?
Forrester Research provides insights about customer behavior and business technology to help organizations on their innovation, marketing and sales efforts. They provide solutions for their customers to manage market research, digital marketing, customer experience, platform strategy and advanced technology.
Forrester is engaged in the ESG field through its creation of the Forrester Energy Scenario model that measures how companies are changing based on energy prices. The model uses five categories to determine how companies are changing: Efficient Operators, Value Takers, Innovators, Providers and Leaders.
This model is based on an extrapolation of data from 33 North American electric utility companies. They used the data they collected for this research to create a “scoring system” which measures the top ten utilities in four different categories: cost-to-serve, capital and plant maintenance, carbon intensity and general ESG factors.
What is the OCEAN™ rating system?
The OCEAN™ rating system was created by Ernst & Young to measure how companies are performing on their ESG activities. The acronym stands for
- Ownership (people who own the business)
- Credibility (trustworthy, transparent and honest)
- Engagement (engaged with customers and employees)
- Accountability (value creation for all stakeholders) and
- Net impact (measure the overall positive impact the company has on the world).
This system rates companies based on five topics: climate change, product design & production, labor practices, customer treatment and community engagement. A company is rated on a scale of one to five for each of these categories. The total points scored from all categories add up to the overall score, which ranges from zero to 100.
How are ESG scores determined?
Companies measure their ESG scores by using a range of different methods. The companies themselves are not obligated to complete them, but they are obligated to provide transparency on the dimensions they have addressed in their company’s goals and objectives. These might include quantifying the carbon footprint of a product over its life-cycle, measuring methane emissions from a factory, or quantifying the percentage of revenue that comes from business partners that have been deemed ethically suspect.
- For example, Environmental goals might include goals to cut greenhouse gases or avoid landfill.
- Social goals might include goals to integrate suppliers into the company’s supply chain, reduce any risks of sexual abuse in the workplace, or maintain positive parental leave policies for mothers and fathers.
- Governance goals might include goals to invest in research for renewable energy sources, increase transparency of company activities by publishing reports, or provide a safe, non-threatening work culture for any workers.
Once determined, the company sets targets and deadlines to reach these goals. These are substantiated by business risks which have been assessed as part of the process. Once completed, these reports are reviewed by an external auditor as well as internal management to ensure that they properly assess the risks that are most important to the company. An outside agency then evaluates the ESG score, and these scores are subsequently used for several purposes.
How can these scores be used to help the company’s goals?
Some of the ways ESG scores can be used is to help a company’s operational goals. It can help them achieve cost savings and better compete in the marketplace. ESG has also been shown to improve brand value, customer relationships, employee productivity, and supplier relationships. Some companies combine them with traditional financial performance measures in order to create a more holistic measure of performance. For example, in the US city of Seattle, businesses in downtown locations receive discounts on their city business and occupation taxes if they develop an ESG score.
ESG scores can also determine the risk level of a company by showing how it responds to its employees and customers. These risks can be premeditated or unintended risks that affect consumers such as product safety and cybersecurity risks.
A company can use their ESG score as a competitive advantage to attract and retain the best employees who prioritize ethical business practices over some other job qualities such as salary. A worker’s priorities may vary, but some workers will intentionally avoid companies with low ESG scores because they do not agree with those practices and values. Employees might also avoid companies with low ESG scores because they lack transparency.
What are some examples of ESG scores?
There are many indices of ESG ratings and scores from companies and countries all over the world. The list is growing all of the time, but here are few. They include:
- The MSCI ACWI Low Carbon Target Index is an index that includes companies who have adopted sustainable methods, such as renewable resources and energy-efficient technologies. It also screens out non recyclable materials and the most carbon-intensive materials.
- The MSCI ACWI ESG Leaders Index is composed of companies that score well on the MSCI KLD Energy criteria and low on negative ESG criteria like human rights violations, bribery, corruption, and product safety.
- Forrester Research’s Trust Index is composed of companies that score well on crisis management, good governance, ethics, and corporate citizenship.
- MSCI’s World ESG Index is composed of companies that score highly on environmental stewardship, social settings, and anti-corruption efforts.
- Sustainalytics’ Global Sustainability Scorecard evaluates companies based upon their current performance in energy efficient technologies , energy efficient operations, climate change mitigation efforts , and policy commitment to sustainability.
- The Sustainability Yearbook ranks over 6,000 of the world’s largest companies on environmental impact, social impact, governance, ethical performance, supply chain management , innovative practices, product responsibility, public commitments, corporate citizenship, and transparency .
- Ernst & Young OCEAN™ focuses on organizational culture, environmental performance, social impacts , ethics and reputation .
- The Dow Jones Sustainability Index is composed of companies who score well on environmental/climate change, employee diversity and development, customer relationship management, product responsibility and innovation.
- MSCI’s KLD 400 Social Index evaluates companies based upon their level of socially responsible investments used to create positive environmental, social and economic outcomes.
- Gartner’s Corporate Sustainability Assessment evaluates companies based upon their level of commitment to sustainability practices in four areas: environment, economics, governance, and society.
- The Global 100 Most Sustainable Corporations in the World ranks well performing companies by measuring them against five dimensions that include environmental impact, risk management, climate change strategy, transparency and disclosure.
- The Sustainability Accounting Standards Board (SASB) recognizes companies that are transparent about their ESG performance.
- MSCI GII ranks Countries based on how well they manage their environmental, social and governance issues.
- The Global Energy Architecture Performance Index ranks countries based on their energy performance on the basis of GDP per unit of energy use, level of taxes, quality of infrastructure, etc.
- The Leadership in Environmental and Energy Performance (LEEP) program is an open membership network of state, provincial and local government agencies that are working to improve energy performance in their facilities.
- The Global Sustainable Tourism Criteria (GSTC) was created by the Global Sustainable Tourism Council (GSTC) for tourism businesses to rank them according to how well they meet ESG criteria.
Again, ESG scores are determined by companies themselves through their long-term vision, policies, plans, goals and objectives. They then decide how to reduce the ESG risks the company faces in order to make an impact on society. They measure these risks against opportunities available within each industry they operate in, which is how they determine their ESG score.
But validation is also important. MSCI, Sustainalytics, Gartner, Forrester Research and the Ernst & Young OCEAN™ rating systems are just some of the many organizations that perform these ratings. Think of it a sustainability coaching.
What is the interest of Governments with ESG scores?
Governments and companies are beginning to use ESG scores to assist them in their investments. The interest of governments is that they can identify potential obstacles and opportunities related to sustainability, such as the understanding of risks and mechanisms to address such issues. Governments want to ensure that they are investing in projects that will not only give them a good return on their investment, but also will be sustainable in the long-term.
Governments are also responsible for establishing laws and regulations related to corporations, which can be heavily influenced by ESG scores. Because ESG scores rank certain companies as having more sustainable business practices than others, this is important for government officials to keep in mind when considering the implications of their policies.
The interests of governments are mainly determined by changes that may need to be made based on ESG scores. If it is important for companies to act more sustainably, then certain policies will have to be adjusted accordingly so that new laws and regulations can be made while still maintaining competitive advantage with other companies. This can be seen as an opportunity, such as the possibility for new jobs and businesses to be created as companies begin acting more sustainably. It is their job to develop and enforce environmental and social statutes and regulations, which companies need to adhere to if they want to do business in the country.
What is Responsible Investment?
Responsible Investment is a strategy wherein investments are made with consideration for the environmental, social and governance issues facing the company. This involves investing in companies that have good ESG ratings.
What are the Challenges Facing the Development of Standard ESG Scoring?
One of the biggest challenges facing the development of standard ES-score is that companies’ environmental, social and governance policies are constantly changing. Because companies do not have a standardized process when reporting their ESG data, it could be challenging for scoring companies to gather accurate information.
How to set your own ESG score
If an ESG score is set by the company itself through its long-term vision, policies, plans, goals and objectives then the natural steps to setting your own score would be:
1. List your key company values
2. Determine which of these values are directly related to the environment, society and governance – ESG
3. Add specific elements that highlight how your business performs against these objectives in order to live up to your vision and company values
4. Determine what actions must be taken and what you will measure in order to achieve these standards
5. Communicate and integrate this information into your business plan and set specific goals and objectives that will lead you to achieving a high ESG score.
For instance you might want your company to produce less CO2 emissions or use less harmful substances in manufacturing your product. An example of a non-financial metric that might also be important to you is whether or not employees can take up smoking in designated smoking areas or if they have access to nutritious food in the break room. You don’t need to do a full evaluation of all ESG metrics that are important to you. Your score is a way for you to communicate your priorities to the public and prove that you have considered how your work affects the environment, society and governance. By setting goals related to ESG factors you allow yourself room to be accountable against these standards in order to improve over time.
What did we learn today?
In conclusion of how ESG scores are set by companies themselves, the ESG score is not determined by any regulatory agency, but rather it is a score that reflects an organization’s own commitment to environmental stewardship and social responsibility. This is measured through a company’s long-term vision, policies, plans, goals and objectives. And you can get started today.
Caveats, disclaimers & ESG performance
We have covered many topics in this article and want to be clear that any reference to, or mention of score, ratings, performance, metrics, factors, company’s performance, data, bloomberg data services, rating agencies, risks, corporate governance, reports, criteria, manage risks, issues, asset managers, scoring, dow jones indices, company’s business relationships, evaluate companies, solutions, investing, collecting data, disclosures, climate change, rating agencies, disclosure, climate risk, renewable energy, portfolios, social and governance, report, sustainability accounting standards board, Thomson Reuters, investment decisions, ratings agencies, future risks, matters, company performs, greenhouse gas emissions, sustainable companies, environmental scoring factors, company reporting, governance data, anticipate future risks, good scores, corporate knights, annual reports, supply chain, corporate social responsibility, good score, public companies, industry peers,, natural resources, company self disclosures, carbon emissions, legal and compliance issues, environmental protection, financial commitments, governance scores, sustainable investing, quantitative metrics, policies, publicly available data, executive compensation, single company, company’s score, risk ratings, impact investing, standards or missing data in the context of this article is purely for informational purposes and not to be misconstrued with investment advice or personal opinion. Thank you for reading, we hope that you found this article useful in your quest to understand ESG.
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.