ESG has significantly influenced investment decisions in the EU. As reducing carbon footprint and improving diversity in the workplace become increasingly important, companies must make their environmental, social, and governance efforts more transparent to ensure accountability.
A survey conducted by PwC revealed that 83% of consumers believe that businesses must actively contribute to improving the best ESG practices. The study also showed that 91% of business leaders recognize their immediate responsibility to act on ESG issues, while 86% of companies prefer to partner with organizations that actively act on pressing ESG matters. But there is always a catch.
A recent report from Bloomberg revealed that almost 25% of traders believe greenwashing accounts for over 50% of ESG. While dreaming big is important, developing an authentic sustainability strategy for your business goes a long way. Hence, companies should devise achievable ESG goals to avoid misleading the public.
What is an ESG Score?
An ESG score is representative of the company’s long-term environmental, social, and governance commitments. The score is a way to evaluate and measure a business’s performance against the most crucial sustainability metrics. ESG scores are brought about by the responsible rating platforms that take into account the company’s energy efficiency, diversity, environmental efforts, worker safety, among other criteria.
Companies with high environmental, social, and governance scores are seen as more successful at managing sustainability risks than those with a lower rating. Overall, the high ESG scores, combined with economic indicators, allow investors and governments to identify companies with high long-term potential.
How is an ESG score calculated?
The independent, third-party agencies are generally responsible for evaluating the company’s affairs to determine the most appropriate ESG score. Numerous rating agencies evaluate corporate sustainability, but among the most notable are Bloomberg ESG Data Services, MSCI ESG Research, Dow Jones Sustainability Index, Thomson Reuters ESG Research Data, Fitch Ratings, and S&P Global. Different ESG agencies develop individual evaluation criteria while assessing the companies’ sustainability commitments.
Analysts use data from various sources while determining the score for each business. Evaluating agencies use voluntary business disclosures, government databases, academic research, security filings, and news articles. Specialists heavily rely on data from the Global Reporting Initiative (GRI), the Value Reporting Foundation’s (VRF) SASB Standards, CDP, and the UN Sustainable Development Goals (SDGs).
Unlike financial indicators, which can be easily measured and displayed in charts or tables, environmental, social, and governance efforts are more difficult to quantify. However, ESG specialists are responsible for creating unique algorithms to help identify a company’s ESG score — a rating that takes into account the company’s carbon footprint, board diversity, safety systems, and other factors relevant to the particular industry.
MSCI ESG Ratings
For instance, MSCI developed a 0 to 10 score that relies on hundreds of relevant indicators. The score is assigned to each pertinent issue and evaluated based on its timeliness and probable impact. For example, the index gives the most importance to subjects with the highest impact potential, exhibiting effects within two years or less. Meanwhile, the issues with the lowest potential for impact and a timeline of five years or more have the smallest weight in the scoring process.
The market is largely affecting the most prominent and urgent matters for every company in question. This way, worker safety is especially relevant for industrial companies, while carbon footprint is an urgent issue for the energy sector. The final rating is largely determined by industry-wide comparisons, serving as a useful tool for understanding the average, low, and high ESG scores among industry peers. The MSCI ranks companies according to their performance, dividing them into three categories: leaders, average performers, and laggards.
The rating allows investors to fully grasp the spectrum of ESG scores within the industry and determine the companies with the highest potential.
What is Measured by the ESG Score?
ESG is a measure of an organization’s environmental social, and governance impact, revealing a variety of issues within each category. For instance, the rating helps to assess a company’s carbon footprint and sustainability initiatives, how often it contributes to the community and details about its legal compliance.
The environmental category covers several factors, including greenhouse gas emissions, toxic, packaging, and electronic waste, as well as water and biodiversity use, among many others.
Social scores cover such issues as worker safety, labor management and standards, consumer protection, and quality assurance.
Lastly, governance scores are representative of board diversity, accounting and business practices, corporate ethics, and tax transparency.
Overall, the assessment categories vary from business to business, as certain factors may not be applicable and therefore analysts cannot evaluate them properly.
How do Companies Use ESG Scores in the Market?
ESG ratings vary greatly based on their market use since the specialized agencies carefully develop systems to inform diverse groups of stakeholders. Individual investors use the scores to evaluate potential credit risks, assisting individuals in making informed capital allocation decisions. Others may use the data provided by the ESG analysts to improve human capital management and employment decisions.
The Carbon Disclosure Project (CDP) is a non-governmental initiative rating corporate performance on key environmental factors. The NGO works to assess the company’s carbon emissions, climate change contributions, water pollution, and more. The CDP is a popular tool among asset managers, who use the screening results to determine the most and least green companies in a given industry.
Another prominent example is the NGO Just Capital, which primarily focuses on corporate performance. The organization investigates how companies contribute to local communities, respect their employees, and create value for suppliers. The scores provided by Just Capital are especially valuable for prospective employees or company beneficiaries while searching for an employer or a supplier.
How to Properly Set ESG Goals to Avoid Greenwashing?
Set Goals Relevant to Your Industry
The company can only feel confident while putting forward its ESG initiatives if they are applicable to the organization’s industry. It would be a waste of time and money to invest in efforts that have no bearing or connection to the company’s operations. ESG provides a comprehensive framework, allowing your company to re-evaluate its environmental, social, and governance programs. The goals must reflect the nature of your industry to allow external evaluators to conduct a sweeping comparative analysis. Well-comprised ESG goals can determine the score that would properly reflect your business sustainability initiatives. Overall, having a clear focus is beneficial, as concentrating on too many metrics that might prove unattainable in the future is a failed strategy.
Find Your Area of Focus
A business should consider investing in the development of a set of key principles that could help company representatives stay focused and work on fulfilling their ESG objectives. The principles should also be reflective of your industry, as a financing company would not want to focus on transitioning from fossil fuels, as it is not relevant or applicable. Instead, a financing business could focus on the “governance” aspect, energy companies can concentrate on the “environmental” factor, and manufacturers can improve the “social” component of their ESG strategy. After understanding the key focus, a company can highlight the specific aspects of the most relevant issue to their industry. For example, having a specific set of attainable objectives can help in establishing the most authentic and transparent ESG marketing strategy.
Ensure a Strong Narrative
After determining the most industry-relevant focus points, creating strong marketing messages that are also representative of your ESG efforts is key. Investors, clients, and workers are increasingly concerned with ESG scores. Hence, having a positive company narrative is especially vital. Some businesses are afraid of falling into the greenwashing trap, so they avoid announcing their ESG efforts. However, refusing to make any public statement about ESG goals may backfire, as clients and partners are looking for companies that are passionate about sustainability. Thus, forming a company branch responsible for investigating potential misconduct related to companies’ sustainability claims can be beneficial in determining the appropriate media messages.
Stay Ahead of all the Regulatory Updates
The sustainability regulations are often changing; hence, a company might easily lose some of its scores because it failed to comply with the new laws. A business must proactively review all environmental, human capital management, sustainability, and other relevant policies. For instance, attending industry-tailored conferences can be an effective way to stay on the pulse of the ever-changing regulatory frameworks. By not following through with some policies, you could end up paying an extremely high price — hence, hiring a professional legal team can be well worth the investment.
Stick to an Industry-Specific Evaluating Mechanisms
Hundreds of ESG evaluating bodies can make it difficult for a company to choose the most relevant fit. However, choosing a specific set of goals and principles will greatly help you find an appropriate rating agency. As mentioned earlier, The Carbon Disclosure Project (CDP) may be more suitable for energy companies, while Just Capital can suit the companies within the manufacturing industry. Overall, conducting thorough research on the rating bodies used by the competitors may be of great benefit.
