With so many ESG Ratings – How can businesses make it pay?

With so many ESG Ratings – How can businesses make it pay?

With so many ESG Ratings – How can businesses make it pay?

By James Byrne, ESG Consultant

In the recent paper ‘Aggregate Confusion: The Divergence of ESG Ratings’ the writers discussed the relative strengths and weaknesses of the sheer volume of ESG ratings and the diversity of approaches, stating “the level of disagreement [between ratings] is so severe that ratings agencies reach not just different, but opposite conclusions”. This is because like any scenario analysis used by businesses and ratings agencies, the future is by its very nature uncertain, especially when it comes to climate. For an asset managers position, this helps some managers produce alpha when it comes to ESG by finding areas of strength and weakness in businesses, sectors or industries, if they are astute at interpreting climate and ESG ratings data on companies and sectors, which is a growing area of expertise in itself, and one which will hopefully accelerate ESG reporting.

Like most investing analysis, opinions will vary, so it shouldn’t be a surprise that ESG ratings are similarly diverse (especially since they are forward looking). Unlike traditional portfolio analysis, ESG data from the past can be thin on the ground, as most companies haven’t been collecting environmental or social/diversity data for very long, as Ben Yeoh mentioned in a recent talk at the CFA. This further complicates creating accurate predictions, and hence the large elasticity of ESG ratings and approaches currently on show. We shouldn’t view this as a bad thing however. If we look at the history of investing, there have always been a number of different approaches to analysis, from value investing to fundamental analysis, and many others. ESG is finding its feet, attempting to answer big questions, this is good news.  

From a business perspective, however this means it is crucial that a company’s individual ESG and sustainability approach, and the reporting of these is appropriately executed. For a business, large or small to know exactly how to communicate their sustainability work and how to adapt strategies and risk plans, management and the board must understand how their business fits into the wider landscape, be that sectoral, regionally or just in general. Understanding what rating agencies have in common when it comes to rating the performance of your sector, for instance, requires companies to step back for a moment and do some research. This is where getting a competent ESG consultant who can help is crucial. Many Sustainability consultants will suggest whatever is the hot topic of the day such as reduce single use plastic or divert waste from landfill. However, a superior consultant will also look at it from a ratings perspective so that you maximise both the physical and social impact of your green agenda, while hitting the green ticks from ratings agencies recognised by investors in your sector or region. Former governor of the Bank of England Sir Mark Carney set out the celebrated ‘Task force on Climate Disclosures’ (TCFD) in 2017 and which is now gaining huge traction globally. The TCFD, uses a logical methodology to help companies assess and report on the implications of climate change on their particular business. It sums up nicely some of the key thing’s businesses need to hit when it comes to their communication of climate risk and strategy, and how to mitigate financial risks posed by climate change. These are that organisations disclosures must be relevant, specific and complete, clear, balanced and understandable, consistent over time, comparable within a sector, industry or portfolio and be reliable, verifiable and objective and provided in a timely manner. Sounds tough, but getting right is not difficult if you understand where you fit into the business and investing landscape. If you disclose properly, your company’s ESG rating will be excellent and your sustainability work, the most impactful. ESG is good for business. 

 

Sources

Investment week-Sept 2020

https://www.investmentweek.co.uk/analysis/4020373/esg-ratings-future-solutions 

TFCD Resources- June 2017

https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-2017-TCFD-Report-11052018.pdf 

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