How to understand what your EGS reports are telling you and how to get the greatest value from the information.
Literally hundreds of organizations are requesting ESG data from companies like yours, and about 10 to 15 major ESG rating agencies are actively providing detailed rating reports. Each one of them uses its own rating scale and reporting format. This can make it a real challenge for companies to keep up with requests for information as well as with understanding the reports the agencies produce. There’s no easy answer to which rating firm or report should matter most to you. And that’s where we can help.
In general, portfolio managers consider ESG ratings from up to three different agencies when building out their models, and which reports a PM chooses to consult is really a matter of their own preference. Several rating agencies are rising to the top today, but that doesn’t mean they will be the final winners or the only reports that ultimately matter.
That said, if you’re just getting into the ESG game, trying to drink from the firehose and understand dozens of different reports all at once will no doubt overwhelm and frustrate you. We suggest focusing on two of the major rating firms, MSCI and Sustainalytics. You can request free copies of your ESG report from these firms, as well as others, including Bloomberg, Morningstar and Thompson Reuters. Once you have a couple of reports in hand, don’t be surprised to find differences between them. Again, the best advice is to start slow, review two or three reports, and get a handle on the most critical information.
Specifically, here’s what to look for and what you should hope to take away from each report:
1. Understanding what information the rating agencies are using to derive their scores.
Rating agencies generally outline the materials that are reviewed for scoring purposes, such as external company disclosures (website materials, sustainability reports, etc.), external databases, and media, news articles or trade reports that may exist related to key ESG issues.Keep in mind that publicly available filings, articles, and reports related to ESG “controversies” often factor heavily into ESG ratings. If your company has recently been the subject of any less-than-positive coverage, it’s critical that you proactively share any information about your efforts to rectify or address problems and issues brought to light by these reports.
You can do this through your website or investor communications. Or you can provide it via rating agency questionnaires. Representatives from Sustainalytics say that 65% of the firm’s information is from non-corporate sources, primarily because companies don’t disclose enough information on their own, and they wish they would. The more you can provide about your company’s initiatives, the more your score will accurately reflect your organization’s ESG efforts. Remember, with ESG, your first job is to make sure rating agencies have all the facts and information they need to evaluate you fairly. Once you’ve made that effort, you can turn your attention to improving your actual score.
2. Areas where you need to improve.
Regardless of the rating scale a reporting firm uses, most will clearly flag negative marks in the front end of the report.Once you review the specific environmental, social, and/or governance factors that are bringing down your total score, you need to answer the following question for each factor: Is this an area or initiative that your business really needs to invest in developing and that should move to the forefront of your ESG strategy? Or is this an ‘uninformed’ rating?
Notice we said uninformed as opposed to unfair—and this goes back to the first point, making sure agencies have the facts they need to make an accurate evaluation. In our experience, we find that companies are usually making an effort in many of the areas where they are being negatively marked. If, for example, you get a low mark related to your carbon footprint, but your organization is already taking serious steps to lower its environmental impact, it may be that the rating agency just can’t find this information. The onus is on your firm to provide details through answers to rating agency questionnaires as well as via important resources to external stakeholders and investors, namely your website, annual report, and/or corporate sustainability report.
3. Areas where you are strong.
These areas deserve almost as much attention as the areas where you are getting lower scores. Strengths and high scores are typically noted alongside your negative ratings, usually in the upfront score on the first page of each document. Reports typically include discussions of these strengths versus the company’s peers.Since these factors are giving your score a boost, you will want to make sure that you have processes in place to continue to prioritize them and that you keep proactively speaking about these efforts and activities in public channels. Remember that it’s important to communicate your biggest accomplishments and any changes in the past year, but you should also include details that show how specific ESG factors are heavily ingrained in your corporate culture. In other words, emphasize what you have done recently to improve, but also highlight what your organization has been doing for years in these areas.
Finally, remember that high marks show what you’re doing well today. Investing the necessary time and attention to keep those scores up will ensure you continue to see those green marks after each annual review.
4. The specific factors that make or break your ratings.
In general, rating agencies give you a total score that is made up of your sub scores in environmental, social, and governance. Keep in mind that different rating agencies give different weights to the E, S, and G. One firm might weigh environmental as 50% of the overall score while another firm weights it as 33% of the total score. This helps explain why your ratings may be different from one firm to the next.In addition, each individual company’s score is weighted differently based on risk factors associated with that company’s industry, location, types of products offered, and several other factors. For example, a manufacturer’s environmental score will have a larger impact on its overall score than a bank’s. For the bank, social or governance will likely factor more heavily into the total score. Even among industry peers, ratings for environmental, social, and governance could be slightly different across the different rating agencies. One company may be weighted 25/50/25 for E, S, and G while its direct competitor is weighted 20/60/20.
You can reach out to the specific rating agency for additional resources to better understand your rating and the weights assigned to each sub factor. Knowing the importance of each element considered in your score will help you identify the key areas that matter most to your score and help you best allocate your resources as you refine your ESG strategy going forward.
The bottom line is there’s a lot of information to digest in these reports. Taking them piece by piece will help you understand what you’re doing well, which areas could use improvements, what deserves more resource allocation, and what you need to start communicating more clearly to address gaps in information and ensure scores that most accurately reflect your efforts.
Take a deeper dive into your reports.
At Clermont Partners, we work closely with several key rating agencies and invest in the services and data they provide in order to better understand their rating practices and the nuances behind their scores. If you’d like to discuss your ratings in more detail and begin to develop an ESG strategy that best addresses the unique concerns of your investor base, contact us today to start a conversation.