Behind the ratings

Reporting on sustainability is now commonplace, but directors can end up with an alphabet soup of frameworks and methodologies that lack clarity or consistency. Dr Alex Gold AAICD sifts through the ESG ratings and the learning opportunities for your organisation.

As sustainable investing grows, organisations are increasingly recognising the value of sustainability (ESG) reporting as a way of demonstrating their credentials to the market. The market has responded by using reporting to create ESG ratings that attempt to distil the entirety of a company’s approach and performance into a single metric. How can companies use these ratings to their advantage?

Reporting on sustainability is now common, with many entities producing standalone sustainability reports or integrating ESG content into their statutory reporting (through integrated reporting, say). But the increased prevalence of sustainability reporting hasn’t necessarily made it more coherent. While there’s a proliferation of reporting guidance available for organisations to use, many sustainability reporting frameworks are substandard, compliance-focused and fail to offer strategic value. The lack of clarity on a best-practice approach has been driven by the fact that ESG reporting remains, for the most part, voluntary. Recent efforts in the EU and NZ notwithstanding, governments across much of the world remain silent on a preferred approach to sustainability reporting.

The increased prevalence of sustainability reporting hasn’t necessarily made it more coherent. The investor is met with a dizzying array of ESG metrics and priorities within corporate disclosure that they have to factor into their decision-making.

There’s also the reality that ESG issues will vary in importance across industries. Waste from packaging is important for consumer goods; green building ratings are relevant for real estate; and financial literacy is a focus for financial services. The investor with a global investment universe is thus met with a dizzying array of ESG metrics and priorities within corporate disclosure that they have to somehow factor into their decision-making. Many investors turn to third-party services that try to standardise corporate reporting and provide insights on organisational performance. These services generally fall into one of three groups:

1. ESG ratings providers

These are organisations that review a company’s public disclosure and calculate a rating for the company (0-100/A-F) based on a proprietary scoring framework. Examples include Sustainalytics’ Company ESG Risk Ratings, MSCI’s ESG Ratings, ISS’s ESG Ratings, FTSE Russell’s FTSE4Good Index Series and Vigeo Eiris’s ESG Assessment.

While ratings providers don’t rate every company on the planet, if they do publish a rating for your company, you can’t get out of it. At the same time, a provider will usually engage with your company during the rating process, but only for the purposes of clarifying the applicability of your existing public disclosure (that is, they won’t accept information that is not disclosed publicly).

Because these ratings providers rely exclusively on corporate reporting, companies can usually make meaningful gains in their rating simply by improving the comprehensiveness and alignment of what they report. These terms are generic — this is how they apply to ESG ratings.

Comprehensiveness means reporting as much as you can, even if it is disclosed in a sustainability data appendix separate to the annual report (which is a useful way of achieving comprehensiveness in disclosure without overcomplicating the flagship report). For example, you may never have reported on workplace fatalities, because your company is involved in low-risk office work. But to the ratings providers, failing to disclose fatalities (even if it is zero) is seen as lacking transparency and your rating will suffer for it.

Alignment means matching the metrics your company uses to the metrics that the ratings providers are assessing. For instance, your company may report on a broad “women in management” figure, while a ratings provider is scoring your company on the percentage of “women in executive” positions. This mismatch can result in the ratings provider simply marking the “women in executive” metric as “not disclosed”. Avoiding this is easy. If your company is already reporting on the issue, then the disclosed metric just needs to align better with the ratings providers’ frameworks.

While it would be unrealistic to try to report on every metric requested by every ratings provider, a strategic comparison of existing reporting to the ratings frameworks can uncover opportunities to enhance your company’s standing simply through improving reporting.

2. Investor survey organisations

These organisations invite companies to respond to surveys/questionnaires they administer and then score the responses according to a proprietary scoring framework. These surveys are not your friendly SurveyMonkey feedback forms; they are exhaustive diagnostics that require hundreds of pages of content from companies.

Examples include the S&P Global Corporate Sustainability Assessment (also referred to as the Dow Jones Sustainability Index), CDP’s Climate Change, Water Security and Forests questionnaires, GRESB (formerly the Global Real Estate Sustainability Benchmark), the Workforce Disclosure Initiative, and the Principles for Responsible Investment’s public signatory reports.

Companies opt in to these surveys. While an organisation such as CDP, for instance, will publish the fact that the company did not respond to an invitation to participate, CDP will not independently review the company’s climate change disclosure to arrive at a score (unlike ESG ratings providers such as Sustainalytics and MSCI).

A company’s sustainability reporting contributes to its investor survey performance in two key ways:

• Transparency — unlike ESG ratings providers that rely exclusively on public disclosure, companies are able to respond to most investor survey questions with information that is not available in the public domain. However, many of these questions ask companies to support their responses with publicly available evidence. If this evidence is not provided, then the scoring may be impacted or the response to a particular question thrown out altogether. The better the existing reporting, the more likely it will be able to support the investor survey submission.
• Re-use of content — many investor survey questions can be addressed by simply transferring content from the latest corporate reporting suite. If this reporting is comprehensive, a company will have ready-made answers to help complete the investor surveys. Less comprehensive reporting means a company will need to apply additional effort to research, draft and review its investor survey responses.

If your company wants to benchmark itself and enhance its standing by participating in investor ESG surveys, the survey requirements should be integrated into the annual reporting suite from the beginning of the process. This ensures that the reporting addresses the factors covered in the investor surveys. It also creates efficiencies for your company, because the reported content can be used over and over again as needed. Your company will be rewarded for transparency and will be able to respond to investor surveys (and many other ad hoc investor ESG requests) with ease.

3. Data aggregators

These trawl corporate websites and reports before aggregating information on proprietary platforms and selling access to investors and others. Examples include Refinitiv, ICE Data Services and Bloomberg Terminal. These aggregators sometimes also include ESG ratings published by ESG ratings providers or the investor ESG surveys described above, illustrating one of the many connections between the three categories of services explained herein. Companies cannot opt out of being included in an aggregator’s platform, and the aggregator rarely provides an opportunity for a company to correct any misinterpretations without becoming a paying customer of the aggregator. When this is combined with algorithmic methods to compile company data, it can be hard for a company to engage with an aggregator to understand how it can improve its disclosure.

Furthermore, the ESG ratings providers and investor surveys described above are generally set up to consider ESG exclusively. This means they have deep knowledge of how ESG issues impact value creation across industries. In contrast, data aggregators have existed for decades as financial and market-data houses and have more recently incorporated an ESG offer in response to the growing interest from the investment community. The difficulty in engaging aggregators, combined with their relatively recent entry into the ESG space, means they’re less useful for informing corporate sustainability reporting when compared with the ESG ratings providers and investor survey organisations. Nonetheless, they remain users of corporate sustainability reporting and have a wide subscriber base, so it’s worth being aware of their role in the investment landscape.

Dr Alex Gold is head of ESG and CEO of sustainable business strategy advisory BWD Americas.