October 4, 2022
Key Points
- Business leaders often raise questions around ESG ratings, and recent headlines risk making matters even more confusing.
- Best practices for leaders include improving risk management, enhancing transparency, and undertaking engagement.
- With the right insights, companies can benefit from ESG ratings and align business strategy to pressing social and environmental issues.
ESG in general, and more specifically ESG ratings, have been in the line of fire recently. The critics have been loud, with strong accusations of a false and flawed system.
While some critiques are justified, there is a lot of misunderstanding around ESG ratings, which continue to play an important role in benchmarking sustainability information and informing investment decisions. It is important to understand what ratings are, and equally what they are not, to avoid these misinterpretations.
With a background in the responsible investment industry, I know ratings often raise questions and sometimes frustration among companies—recent headlines risk making matters even more confusing. I’ve received numerous questions from member companies trying to figure out how the rating system works and how to engage with rating agencies.
With the right insights, companies can grasp the benefits of ESG ratings and how they can play a positive role in self-assessments, benchmarking against peers, and aligning business strategy with respect for social and environmental issues.
With this backdrop, here are five common dilemmas with key recommendations for business:
How much should I care about ratings? The short answer is—a lot. ESG ratings are now a mainstream tool in institutional investors practice, used as one of several factors to evaluate ESG performance and make buy or sell decisions. Ratings help benchmark a company against peers, identify leaders and laggards, and get a sense of the ESG landscape within a given sector. For example, they show up daily on Bloomberg terminals around the globe, and often companies are simply not in consideration for investment if they do not pass a certain barrier—so ratings are critical for issuers.
It is a jungle out there and I don’t know what to focus on. The number of questionnaires can seem overwhelming and raise concerns about how to allocate already limited resources. A first step is to find out how your critical investors are using ESG ratings, identify which issues they believe are important, and what data they are looking for. MSCI and Sustainalytics are the most frequently used rating agencies. Ensure that you are directly engaging with your investors to understand their expectations. It is advisable to monitor for presence on any investment blacklists, as this can result in exclusion from ESG products. If your rating is poor, communicate to your investors how you plan to address the issue.
I am disappointed with my rating but not sure how to contact the rater. I have heard many executives who are unhappy with their ESG scores, claiming it is based on incomplete research or a lack of contextual analysis. Reach out to the raters and build a dialogue, get feedback, and see what it takes to improve your rating. It is also in their interest to collaborate on gaps and be transparent around methodologies, so it should be a win-win. Look through the rating report shared with you—this should provide contact information for the analyst, and log in to their online platform where you can include additional information.
I have released a new report, but my rating has not improved. Ratings are updated annually, so perhaps your latest report has not been reviewed yet. A typical rating agency evaluates around 700 criteria for thousands of companies, which takes time. It is possible that the analyst simply missed information, which underlines the benefit of establishing a dialogue with the raters for verification purposes. Even when information is retrieved, many raters require this information to be made public. This is a way of pushing companies toward improved transparency and accountability.
I have just become B Corp certified/signed up to SBTi, but still have a poor rating. External certifications matter less in this context, as ratings measure how a company approaches ESG from a risk management perspective, rather than from business impact. A company can have a product with positive environmental impacts, but if it does not manage labor-related risks or corporate governance, it will never receive a good rating. If you want to improve your score, focus on implementing solid ESG management systems and report transparently on it; this will positively impact your rating at the end of the day, as a mere side-effect.
ESG ratings are not a silver bullet, but that does not mean they are not useful. They have played a key role in mainstreaming sustainable investing and educating the investor community on how sustainability issues are relevant to business. It is still a nascent industry lacking standard definitions, which is a valid part of the criticism, but it has never claimed to be an exact science. Investors are a powerful actor in the transition toward a more just and sustainable world, and ratings are an important part of their toolbox to get there.
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