How is a company’s ESG rating made? Who is considered a leader or a laggard? How does an accessible environment improve the result?
There are parameters of a company’s success and sustainability that go beyond financial metrics. Investors are paying more and more attention to ESG ratings. However, we have to note that today there are still quite a variety of indicators, and the ecosystem has some teething troubles as well.
The English abbreviation ESG (environmental, social, governance) and its meaning are probably already known by the majority of economic specialists. However, it is becoming more and more frequently used in common language as well, as there are basic human values behind the letters: Let’s take care of our environment (E), be sensitive to the challenges of people who find it more difficult to make ends meet, move, or find their way around (S), and fight against corruption and injustice (G).
It’s expected by more and more people.
The sustainability and normality appearing in the letters started to be taken seriously by investors as well. Factors that can no longer be read from financial reports, balance sheets and profit and loss statements are gaining more and more emphasis in the assessment of individual companies, but at the same time, investors still want to get an idea of the companies. After all, they know that a company with a weaker ESG index represents a greater risk, while a company with a good index has a more favourable future potential.
It is not an exaggeration to say that these rankings can determine the fate of billions of dollars in investments every year, but the ratings can be used by job seekers, business partners, or customers as well. Even the rated companies themselves can learn from them since objective feedback helps to understand the company’s strengths and weaknesses, as well as identify risks and opportunities.
It has burst into the decision-making process.
Institutions specifically specialising in investments, fund managers, pension funds, and investors in insurance reserves would not be able to make responsible decisions today if they did not also rely on ESG scores.
Yes, but if this is such an important aspect, then obviously, it is also important to detect which indicators express the situation properly. After all, when we see in the accounting system of a given country how much the company’s indebtedness, profitability and turnover rate, EBITDA, taxable profit or dividends are, we can come to the same conclusion. But what is a good and objective ESG score, and what is the purpose of such a number anyway?
The ESG score aims to measure the long-term risks the given company is exposed to in terms of its environmental, social and corporate management tasks and how prepared the company is to meet the current and future expectations of regulators and society.
It is hardly surprising that a high score, i.e. a strong ESG rating, indicates that the company manages these risks well compared to the field (it is very important to note that this is a relative score, other companies also have ratings), while a low ranking shows that the company still lags behind the sector average, and has many risks that are not yet adequately managed.
The range of indicators
ESG scores are currently calculated by dozens of agencies specialised in ranking, the largest of which now evaluate thousands or even tens of thousands of companies. Bloomberg ESG Data Services, the Dow Jones Sustainability Index, MSCI ESG Research, Sustainalytics, Thomson Reuters ESG Research Data, S&P Global, Fitch Ratings and Moody’s Investors Service are all in the global field.
Well-known brand names have established their reputation in other areas with even centuries of reliability.
It is beyond question that there is still a lot of confusion about ESG today. The unquestionable professional excellence and evident benchmarks, such as in credit ratings, where everyone knows which 3 or at most 4 rating companies are worth paying attention to have not developed yet.
Anyway, the parameter systems of individual qualifiers may contain individual criteria, they may use external, objective measures at the same time, or they may also ask for answers based on self-declaration. Some kind of unique system is also necessary for how the different characteristics can be expressed by the given qualifier in a single score. For example, how can the company’s carbon dioxide emissions, the ratio of incomes between female and male managers or the level of accessibility of the company’s offices be quantified in a single score?
The relative success
We will not delve into the details of these now, since there are really as many customs as there are countries, but there are many interesting and public technologies. The point is always weighting because more important questions should be given more weight, as should those that describe the current situation. Disturbances of a smaller scale, damages and omissions that occurred formerly are taken into account with less weight.
As we have already mentioned before, after percentage weighting the ESG risks, it is extremely important to evaluate relatively, i.e. the companies are compared with their peers. As a result, even an oil company can have a good ESG rating if it is at the forefront compared to industry standards, and a renewable energy company can have a bad rating if it treats its employees badly or if it has caused serious environmental destruction before producing emission-free energy.
The case of Amazon
Take the case of a well-known company, Amazon, as an example. One of the most valuable companies in the world is only kind of „average” from an ESG point of view. While it excels in corporate governance principles, respect for privacy and data security, compared to e-commerce standards, its ecological footprint is only average, and it performs poorly in valuing its workforce.
The mix above only gave Amazon an „average” rating. Because the companies fall into different cohorts, there are leaders and average or lagging companies.
Signs and letters
The use of letters is also known among ESG ratings, just like in the case of credit ratings. AAA is for the best, ratings with different numbers of „B” letters are for average, and ratings with Cs are for lagging.
Evaluations can look different, but it is inevitable that a score of 50 on a scale of 100, i.e., a rating below average, means no good. However, the number of names or grades used by the given rating company may differ.
What factors matter?
It would be difficult to describe a complex parameter system in all its elements, but here are just a few essential aspects that repeatedly appear by the qualifiers:
- E, i.e. environmental problems: carbon dioxide emissions, promoting or preventing climate change, water use, the release of toxic substances and waste management in general, packaging, the energy efficiency of buildings, and the use of renewable energy are essential components to mention.
- S, i.e. community scores: they reflect the workforce management, the working conditions of the company and even the entire supply chain, health, safety and educational parameters, product safety and quality, consumer complaint handling, accessibility and the level of inclusivity of the work environment.
- G, i.e. management problems: can cover the fairness of workplace advancement, income differences, business ethics, and tax transparency.
Accessibility and ESG
Accessibility also appears as an important element in the practice of the various ESG rating companies. This area also has its own KPIs (Key Performance Indicators), i.e. the most important performance indicators. These are characteristics that can have measurable and self-declared elements.
For example, what percentage of the rented or owned area is barrier-free, what improvements help the groups with special needs, and what proportion of employees work at the company with disabilities?
Anyone who creates a barrier-free environment does not exclude 15 per cent of society (1.5 million people in Hungary) from the circle of employees, partners, and customers.
Why do ESG scores matter?
The evaluation of the scores can be unique; there are significant investment houses that do not even entrust this to external parties but have developed a unique system and rely only on it.
Regardless of the system, investors naturally prefer companies with a better ESG score, because they rightly assume that they will have fewer obligations in the future, they will not be penalized, sanctioned or banned by the authorities, the brand’s esteem and reputation will be better, and the company’s activity and profitability can thrive.
The problems
Despite all of this, it’s needless to say that there are still a lot of questions as well these days surrounding the ESG metrics. It is a young industry, and investors cannot blindly rely on just one of these indicators.
The ESG classification alone cannot be a reliable predictor of market success; the classification criteria and weightings can be disputed and questioned.
Such questions may arise as to how authentic the data based on the company’s self-declaration can be considered, how transparent the methodologies are and whether a conflict of interest situation does not arise. For example, a specific person who performs the ranking also has a financial relationship with the company in question as an ESG consultant.
In any case, there are already unification efforts, ESG ratings can also be regulated, and what is most important: the genie can hardly be put back in the bottle, and the ESG rating will already be part of investment decisions.
Access4you is a social impact startup: we survey and evaluate buildings to provide detailed, credible information about the built environment for the special needs community. Based on the results, we issue a certificate stating that the location is entitled to use the ‘Access4you’ European certification mark, and the detailed data of the site will be publicly available in the access4you.io database and mobile application.
For more information: https://access4you.io/b2b