The current state of ESG ratings - Simply Sustainable

Simply Sustainable

The current state of ESG ratings

As climate change and sustainability move up the investor agenda, more capital is flowing to funds that demonstrate strong alignment with positive environmental, social and governance (ESG) performance. In 2021, over $500 billion of capital flowed into ESG-integrated funds which attributed to a 55% growth of assets under management in these products.1

With this rise, investors are becoming increasingly sophisticated in their use of ESG information and focusing on tools that can help them understand the magnitude of ESG risks they face. To help ensure risk is managed effectively, financial organisations are looking to ESG rating agencies to provide a robust measurement framework. These agencies are designed to analyse current ESG-related disclosures and their impact against an organisation’s material topics, as well as those common within the sector, to determine performance on these issues.

ESG risks can be numerous, opaque and varied across sectors; so, ESG rating agencies are valuable tools to investors as they produce an impartial understanding of ESG performance to determine if an investment is socially responsible or not. For companies, the scores can be used as signals to showcase strong ESG performance relative to competitors when it comes to the impact on society and the environment.

There is currently much debate around the credibility of ratings agencies, as no two ESG rating agencies offer the same service, or the same methodology which creates varying scores and opinions on the same disclosure. For this reason, at Simply Sustainable, we believe that rating agencies are a good start to performance evaluation but shouldn’t be used in isolation to measure the total impact of an asset or organisation. We would also always recommend those agencies which use performance metrics against identified material topics.

 

Who are the main ESG rating agencies?

There are many ratings providers that use corporate disclosures to formulate ESG scores. With an abundance of choice, it is important to determine which ESG rating agency should be used for your organisation. Listed below are the top-rated, globally recognised ESG rating agencies which are commonly used by investors:

  • MSCI ESG Ratings
  • Sustainalytics ESG Risk Ratings
  • Bloomberg ESG Disclosure Scores
  • FTSE Russell’s ESG Ratings
  • Institutional Shareholder Services (ISS)
  • CDP Climate, Water and Forest Scores
  • S&Ps Global ESG Score
  • Moody’s ESG Solutions Group

It is important to highlight that each organisation applies separate methodologies which means the ranking of performance differs, but all include factors such as investment risk, financial strength, social responsibility and environmental sustainability. Agencies which utilise performance metrics against identified material topics of an organisation include MSCI, Sustainalytics. Other agencies such as ISS have a standard methodology, which weigh individual scoring based on applicability. These stand out as top agencies as the analysis is based on quantitative and qualitative data.

Since there is no one-size-fits-all, you will find that some agencies focus on specific areas of ESG performance. For example, the CDP provides environmental data, tools and research that can be used to inform investors about companies that are addressing material concerns linked to climate change, deforestation and water security.

 

The regulatory landscape: what are regulators saying?

At present, ESG rating agencies are unregulated which means that the methodologies go unchecked. The absence of oversight has allowed a proliferation of rating platforms to use corporate statements and generate their own ESG ratings. Unfortunately, this practice has led to some key challenges that firms have to navigate when looking for ESG accreditation. Such challenges include the lack of reliability and transparency of ratings and the potential for a conflict of interest between providers and users. Just as accounting practices standardised over time, so too will a uniform system be developed for rating ESG performance.

 

Why is regulatory oversight important?

Greenwashing presents a greater risk to investors and consumers, where companies oversell their sustainability credentials. Due to the subjectivity inherent in ESG ratings, there is a risk of confusing fact with opinion. For this reason, there has been further discussion of creating regulations which focuses on the transparency of ESG definitions, methodologies and the actions taken to reduce conflicts of interests within ESG Rating Agencies.

 

The regulatory view from three global jurisdictions

Europe

In February 2022, the European Securities and Markets Authority (ESMA) published a “Call for Evidence” on ESG ratings. In June, they published their findings, that companies using ESG ratings should dedicate some level of resourcing to their interactions with ESG rating providers, and that respondents highlighted issues with the level of transparency as to the basis for the rating, the timing of the feedback and the correction of errors.3 As this oversight increases, ESG ratings will become more reliable and useful.

United Kingdom

Recently, the UK’s Financial Conduct Authority (FCA), expressed its support for the regulation of ESG data and rating agencies.4 Doing so will protect both consumer interests, as well as encourage effective competition. Regulators are welcoming the idea of a Code of Conduct which will help govern the different ESG rating agencies. Such actions by regulators will promote transparency, integrity, and the independence of each rating agency.

United States (US)

The current ESG rating environment is turbulent as US regulators take a strong stance on ESG claims. Since 2019, 65 funds have been repackaged into ESG funds to appeal to sustainability-oriented investors.8 The Securities and Exchange Commission (SEC) primed to crack down on misleading ESG claims to influence a fair and efficient market. Following the SEC announcing a $1.5 million fine on BNY Mellon’s fund management for misleading information on ESG investments, even tighter rules and disclosures on marketing have been promised.5 Further within this field, Harvard Business School is progressing their Impact-Weighted Accounts Project to drive the creation of financial accounts to reflect a company’s financial, social and environmental performance.7

ESG ratings enable companies to showcase strong ESG performance relative to competitors. As experts, we can assist your company to pursue alignment with key ESG ratings and frameworks from the outset to shape the narrative in a format that investors and other stakeholders will understand and value.

 

 

1 JP Morgan. Future of ESG Investing.

2 CDP. Climate Transition Plans.

3 ESMA. ESG Ratings.

4 Reuters. Britain decide this year whether regulating ESG Raters.

5 Funds Europe. SEC fines BNY Mellon $1.5m for ESG misstatements.

6 Financial Times. SEC prepares crackdown on misleading ESG investment claims.

7 Harvard Business School. Impact-Weighted Accounts.

8 US Sustainable Fund Flows Slid First-Quarter 2022. Morningstar.

 

 

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