How to Get an ESG Rating Upgrade
(Bloomberg) -- As a public company, there’s no escaping talk about “ESG.” Almost every interview we’ve done in 2021 with a chief executive officer has confirmed the fact.
These environmental, social and governance performance measures are starting to matter, in addition to the core financial measures such as profits or debt. “ESG is in boardrooms all around the world,” John Kerry, U.S. special presidential envoy for climate, said in September.
Among the growing concern over climate change, the pandemic and social inequalities, the rise of ESG is meant to imply that, finally, capitalism is atoning for some of its sins. That profits can no longer be sustained by ignoring the cost of those gains to the planet and its people.
But ask anyone in the industry to define what they mean by ESG and chances are you’ll hear as many definitions as there are investment theses in the world. To try to understand this messy world, we probed the world of ESG ratings along with our colleague Saijel Kishan.
The ratings give investors the impression that they have a ready reference for understanding the environmental and social practices of companies in their portfolios, along with a sense of how they’re governed. Ratings companies take measures such as carbon emissions, workforce gender ratios or a board’s makeup, and then crunch their findings into a single value.
Among more than 160 ratings or data providers, MSCI Inc., stands far above all competition, earning about 40% of all the money investors spend on such data. A company rated “A” by MSCI assures an investor that the likelihood of the company doing good in the world ought to be high. (Bloomberg LP also offers ESG ratings.)
But looking under the hood reveals that the ESG system flips the very notion of sustainable investing on its head. Instead of measuring the risks large companies pose to the world, say through greenhouse gas emissions, water discharges or poor treatment of workers, ESG ratings measure the risk the world poses to the company and its bottom line. MSCI doesn’t dispute this characterization. It defends its methodology for ESG ratings as the most financially relevant to the companies it rates.
Seen that way, a company’s high carbon emissions would only negatively affect its ESG rating if there’s a risk of strict regulations to curb emissions. Instead, ratings reward the most rudimentary of businesses practices.
We discovered this by analyzing 155 upgrades given by MSCI to S&P 500 companies, which are a representative sample of the U.S. economy, between January 2020 and June 2021. Based on thousands of pages of MSCI reports, here are some things companies can do to earn an ESG rating upgrade:
- Conduct an annual employee satisfaction survey
- Adopt a business ethics policy
- Adopt anti-corruption policies
- Institute policies against money laundering
- Have a whistleblower protection plan
- Allow employees to report grievances
- Offer diversity training or programs
- Protect customer data
- Exclude the use of toxic chemicals in products
- Create a graduate or apprenticeship program
- Offer employees stock ownership
- Add “independent” board members
- Offer green bonds (if a bank)
- Improve product quality
- Adopt a recycling policy (if regulations pose a threat)
- Sell some electric cars (if an automaker)
- Create an ESG committee at the board level
- Reduce employee turnover
- “Engage” local communities (if you own gas pipelines)
- Institute “responsible” advertising standards
- Offer training to full-time and contract employees
- Set an emissions target. No need to include Scope 3 emissions.
- Appoint a chief diversity officer
- Hire a chief information security officer
- Win awards as an employer
Each of these factors was cited at least once by MSCI as a key reason for giving a company an ESG rating upgrade. MSCI cited absolute emission reductions as a key factor for only one of its 155 upgrades.
Notice how little “E” features in that list. Among all the factors cited for the 155 upgrades, environmental factors accounted for only 26% of the total. A majority of those “E” citations were for companies that had enough access to water to sustain operations, rather than for ensuring sustainable supply for communities where the plants operate. You can read the full investigation here.
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