ESG Scores

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In recent years, there has been growing interest in environmental, social and governance (ESG) factors as a measure of a company’s overall risk management, sustainability and ethical practices. ESG scores have become a popular tool that help financial managers make decisions about where to invest. They are based on assessments of companies’ performance in different ESG factors.

What is an ESG score?
esg scores explained

An ESG score is an alphabetical or numerical rating that represents a company’s performance in ESG factors. ESG scores usually range from A to C or 0 to 100 or 0-10, with a higher score indicating a better performance in these areas. They are often color-coded too, from green (the best) to red (low performance or high risk).

The score is usually provided by a third-party ESG ratings providers, although some asset managers have their own in-house systems too. The providers analyze different data points to evaluate the quality of the company’s ESG risk management and/or impact. 

 

ESG risk scores are designed to measure a company’s exposure to ESG-related risks. ESG risks can include environmental risks, such as environmental regulation or climate change; social risks, such as labor rights violations; and governance risks, such as the quality and composition of the company board.

 

The ESG risk score or rating provides financial managers with an assessment of how well the company is managing these risks and the potential impact they may have on a company’s financial performance. Expsoure to risks of controversies and corporate scandals feature high in these ratings because they can have important negative effects on companies’ values.

 

ESG impact scores, on the other hand, are designed to measure the positive impact that a company is having on the environment, society, and governance. These scores evaluate a company’s efforts to reduce its carbon footprint, improve working conditions for employees, and contribute to the well-being of the communities in which it operates. The ESG impact score provides investors with an indication of how well the company is contributing to sustainable development.

 

Depending on the investor’s goals and values, they may place more importance on one type of score over the other, or they may use a methodology combine and weight multiple scores.

 

 

 

How are ESG scores calculated?

 

The ESG score is calculated based on a variety of factors decided by the score provider. These factors can be broken down into several subcategories, which could include:

 

Environmental factors: reducing carbon emissions, waste management practices, energy efficiency (examples of impact) and risks to business from water shortages, rising sea levels or climate change regulations (examples of risk).

 

Social factors: health and education, human rights policies, and community involvement (examples of impact) and employee harassment cases, use of forced labor in supply chains (examples of risk).

 

Governance factors: board structure and independence, executive compensation, the alignment of board incentives with shareholders, board diversity, transparency and integrity in financial reporting, corporate ethics policy and sometimes cybersecurity. Governance factors are important in their own right, and for assessing how well a company manages E and S risks too.

 

The data is collected through public filings, company reports, media reports, and surveys and questionnaires designed by ESG score agencies and non-profits.

 

The ESG rating agencies and non-profits use different methodologies and data points to assess these factors and arrive at an overall ESG score for the company. Some agencies use a relative scoring system, where the company is compared to its peers in the industry, while others use an absolute scoring system, where the company is evaluated based on a set of predetermined standards.

 

 

Examples of ESG Score Providers

Several companies and non-profits provide ESG risk scores and ESG impact scores. Here are some of the most well-known.

 

 

Companies that provide ESG risk scores include:

 

1.  MSCI ESG Ratings (measures a company’s management of “financially relevant ESG risks.”

 

2. Sustainalytics (measures the economic value at risk or the “magnitude of a company’s unmanaged ESG risks.”)

 

3. Moody’s ESG Solutions (measures the degree to which companies manage ESG risk factors to financial performance and to society.)

 

4. Refinitiv (measures ESG risk exposure and performance relative to sector and country.)

 

5. FTSE Russell (measures exposure to, and management of ESG risks, in 47 countries.)

 

6. S&P 500 ESG scores (measures exposure to and performance on “key ESG risks and opportunities.”)

 

 

Companies that provide ESG impact scores include:

 

1. CDP (formerly the Carbon Disclosure Project) (provides a “snapshot of a company’s environmental disclosure and performance.”)

 

2. RobecoSAM (uses a “value driver-based ESG scoring approach to find the most sustainable companies.”)

 

3. Dow Jones Sustainability Indices (DJSI) (selects companies that “fulfill certain sustainability criteria better than the majority of their peers within a given industry.”)

 

4. EcoVadis (the score is a “weighted average of four theme scores: Environment, Labor & Human Rights, Ethics and Sustainable Procurement.”)

 

5. Good On You (scores the sustainability of fashion brands on 100+ key issues.)

 

6. B Corp (B Corp certification is a designation that companies meet high verified standards on ESG. It is open to all companies, not only publicly traded ones.)

 

Additionally, many other organizations and initiatives also provide their own ESG scores, depending on their area of focus and expertise.

 

Why are ESG Scores Important?

With growing awareness about the impact of businesses on society and the environment, ESG scores are likely to become more influential in the years to come. ESG scores are important because they provide financial managers with one way to assess a company’s ESG risk management, and/or sustainability and ethical practices. Companies with a high ESG score are generally considered to be more sustainable and ethical, at least relative to their peers, and are increasingly likely to attract investors who are concerned about social responsibility and sustainability.

 

In addition, it is possible that companies with a high ESG score are also more likely to outperform their peers in the long run. Some studies have shown that companies with high ESG scores tend to have better financial performance, lower volatility, and higher profitability than companies with low ESG scores. That being said, some or many high ESG scores may simply reflect good corporate governance, which is already known to be associated with profitability.

 

Why are ESG Scores Controversial?

ESG scores are not a science and they are not regulated. As you can see from the examples above, there is no agreed methodology and each provider’s scoring system involves subjective judgements and specific target markets. Studies have shown that the existing ESG scoring systems do not correlate with one-another. This means that providers are drawing quite different conclusions about the same companies based on their different methodologies and data points.

 

 

Sometimes, this can end in controversy. When electric car champion Tesla was removed from the S&P 500 ESG Index for exposure to social risks, Elon Musk called ESG a scam. The difference between ESG scores that measure impact or risk are also poorly understood by the general public. This has led to concerns about “greenwashing“, when investors believe that companies with high ESG scores are the most sustainable, when in fact, a high ESG score can simply mean companies have low exposure to ESG risks.

 

ESG Scores – What Next?

ESG scores can be an important tool for investors and financial managers who are interested in ESG risk management and/or sustainable and ethical investing. However, it’s very important to consider the methodology and data sources used by each rating agency before making decisions based on ESG scores. It is important to know exactly what is involved with a scoring system by studying and comparing methodologies and data sources. For this reason, most ESG score systems are not intended for general consumption, but rather for licensed financial professionals who might use ESG scores alongside a number of data points and considerations.

 

At ESG Hive, we love to teach about ESG issues, but we never offer investment advice or sell investment products. 

 

Check out our videos to learn more about ESG, and take our Quiz to think about your own ESG philosophy.

Tags :
Environment,ESG and Sustainability Standards,ESG Basics,ESG Investing,ESG Ratings,ESG Strategies,Governance,Social
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