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The acceleration of ESG (environmental, social and governance) brought a fair amount of confusion in its earlier stages about terms and definitions, which meant different things to different people.
Today, the ESG landscape has changed fundamentally: principles and standards have been drawn up globally, bringing ESG thinking into the mainstream, and a substantial number of ESG-advocating organisations offer guidance, platforms and practical support to businesses and investors.
In this article, we explore climate networks founded to share knowledge and drive innovation across businesses, industry, cities and regions, and we cover the major principles for responsible, sustainable business conduct and responsible investing, as well as the key ESG reporting frameworks. Finally, we look in greater detail at the role of ESG rating agencies and ESG data providers.
Top ESG initiatives for businesses to be aware of
Principles for responsible investment
The six principles for responsible investment (PRI) have become an accepted reference point for investors considering ESG issues. Prepared in early 2005 by a group of the world’s largest institutional investors and supported by 70 experts from the investment industry, intergovernmental organisations and civil society, the principles were launched in April 2006 at the New York Stock Exchange. Over 3,000 signatories representing well over $45tn in capital now implement them, committing to developing a more sustainable global financial system.
The equator principles (EPs) establish a risk-management framework for financial institutions to determine, assess and manage environmental and social risk in projects. The EPs apply to all industry sectors globally and to four financial products:
1. Project finance advisory services
2. Project finance
3. Project-related corporate loans
4. Bridge loans
At present there are 105 so-called equator principles financial institutions (EPFIs) in 38 countries, covering more than 70% of all international project finance debt within developed and emerging markets.
UK Sustainable Investment and Finance Association (UKSIF)
Eurosif advocates sustainability through European financial markets. The organisation works as a collaboration of all Europe-based sustainable investment fora, with over 400 members drawn from the sustainable investment industry, totalling over €8trn in assets. The main activities of Eurosif are public policy, research and creating platforms for developing sustainable investing best practices.
UK Sustainable Investment and Finance Association (UKSIF)
UKSIF promotes responsible investment and other forms of finance in the UK that advance sustainable economic development, enhance quality of life and safeguard the environment. Founded in 1991, UKSIF has more than 250 members including asset managers, pension funds, research providers, financial advisers and non-governmental organisations.
UN Global Compact
The UN Global Compact is based on 10 principles that should define a company’s value system and attitude towards doing business. The voluntary business initiative, which unites 8,000 business participants and 4,000 non-business participants, provides a universal language and a framework for corporate responsibility. The organisation also offers hands-on support for businesses with assessing, defining, implementing, measuring and communicating their sustainability strategy.
Top ESG initiatives to help with ESG reporting
Global Reporting Initiative (GRI)
The GRI sustainability reporting standards are the first and most widely used global standards for sustainability reporting. They were designed for use by any organisation wanting to report about its impacts and how it contributes towards sustainable development. Grouped in sets, the “100 series” of the GRI standards contains three universal standards. The “200 series” includes reporting standards regarding economic topics; and the “300 series” and “400 series” set out standards covering the reporting of environmental topics and social topics alike.
To find a reliable measure of ESG performance in an unregulated market, efforts are being made to bring about more transparency and standardisation to the ESG ratings industry
Sustainability Accounting Standards Board (SASB)
In November 2018, the SASB published 77 standards, providing a full set of globally applicable industry-specific standards, which identify the minimal set of financially material sustainability topics and their associated metrics for the typical company in an industry.
International Integrated Reporting Council (IIRC)
The IIRC’s objective is to align capital allocation and corporate behaviour to wider goals of financial stability and sustainable development. The council has created an International Integrated Reporting Framework, which includes principles-based guidance and content elements to govern and explain the information within an integrated report. The IIRC runs its own network, the Business Network, which engages with leading organisations that are committed to furthering integrated thinking, strategy and reporting.
The purpose of ESG rating agencies and ESG data providers
The ESG rating industry has grown considerably over the last decade and has already seen a phase of consolidation as well as a new wave of competitors entering the market – often ESG data providers extending their services to also include ratings.
According to the Global Initiative for Sustainability Rankings (GISR), there are more than 100 organisations that produce sustainability research and ratings on companies. Well-known ESG data companies include Bloomberg, MSCI, RepRisk, Sustainalytics and Thomson Reuters, while Vigeo Eiris, MSCI, ISS ESG, Inrate and Sustainalytics count to the top 10 ESG rating agencies.
In a bid to secure a footing in the lucrative ESG ratings markets, credit rating companies S&P Global bought RobecoSAM’s ESG ratings business, while its largest rival, Moody’s, acquired a majority stake of Vigeo Eiris last year.
How do ESG ratings work?
Based on a composite score of individual ESG indicators – from 70 to 1,000 different indicators with each weighting differently – they provide an overall rating of a company’s ESG performance.
As well as single ESG ratings, many agencies also produce ESG-themed indices, such as the Dow Jones Sustainability Index (DJSI) or the FTSE4Good Index, which include companies that meet certain ESG thresholds.
Contrary to credit ratings, which issuers request and where credit relevant information is collected through a number of interviews and discussions with the company before a rating is published, ESG ratings are in most cases unsolicited. ESG rating agencies tend to make their evaluations based on publicly available information, on corporate sustainability reports and on information from corporate websites. Some agencies will also send questionnaires to firms and invite companies to review and comment on profiles before finalising them.
However, ESG ratings from different providers have been shown to diverge significantly. This isn’t particularly surprising, considering that ESG rating agencies adopt different definitions of ESG performance and different approaches to measure it. The concern is that the divergence is significant: a study from the Massachusetts Institute of Technology found that in a dataset of five ESG rating agencies, correlations between scores on 823 companies were on average a fairly low 0.61. For comparison: credit ratings from Moody’s and S&P Global Ratings are correlated at 0.99.
ESG ratings have therefore received very mixed reviews. Critics say discrepancies in measuring ESG performance make it very difficult for investors to correctly identify ESG leaders and laggards. Different rating approaches similarly cause confusion among companies, which are receiving mixed signals about what good ESG performance looks like.
There’s also concern that there will be companies that know how to tell their ESG story, without evidence of the fundamentals, and equally there will be firms that haven’t yet managed to showcase their ESG credentials in an impactful manner.
To find a reliable measure of ESG performance in an unregulated market, efforts are being made to bring about more transparency and standardisation to the ESG ratings industry. In July 2019, the European Securities and Markets Authority (ESMA) published technical advice on sustainability considerations in the credit rating market and guidelines on the disclosure requirements applicable to credit ratings on whether ESG factors were a key driver of the credit rating action. This will allow the users of ratings to better assess where ESG factors are affecting credit rating actions.
Correspondingly, ESMA chairman Steven Maijoor called for regulating the ESG ratings market, pointing out that “the lack of clarity on the methodologies underpinning those scoring mechanisms and their diversity does not contribute to enabling investors to effectively compare investments which are marketed as sustainable”.
ESMA has now established the Coordination Network on Sustainability (CNS), which will be responsible for the development of policy in the area of sustainable investing, with a strategic view on issues concerning integrating sustainability considerations into financial regulation.
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