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As ESG principles become mainstream in the business world, the market for ESG rating firms is experiencing rapid expansion. To navigate this evolving landscape, it's crucial to understand the nuances of an ESG score and its significance in modern investment and business decisions.
👉 What is an ESG score? Why is it important? And how can companies obtain their own ESG report?
ESG scores provide a quantifiable measure of a company's performance in environmental, social, and governance aspects, offering investors and stakeholders a glimpse into its sustainability and ethical practices. But before delving deep into the intricacies of ESG scores, it's essential to first grasp the fundamentals of ESG itself and understand the breadth and depth of ESG reporting.
Let’s start with the basics - What do we mean by ESG?
ESG stands for Environmental, Social, and Governance. These are the three main pillars of ESG frameworks and represent the topics that companies are expected to report on. The purpose of this reporting is to capture the non-financial risks and opportunities associated with a company’s day-to-day operations.
👉 To learn more about ESG criteria, why not check out our article explaining everything you need to know.
ESG reporting is becoming increasingly important in today's business environment and is now generally considered to be an essential component of both business strategy and brand management.
Companies that report on ESG risks and opportunities are generally considered to be better positioned for future growth and success. This is for a number of reasons, including:
👉 For a more in-depth look at ESG reporting and its benefits, take a look at our article on the topic.
So how exactly does a company go about implementing ESG practices?
ESG reporting is the disclosure of environmental, social, and corporate governance data. It demonstrates a company’s ESG commitment and provides stakeholders with an overview of the practices adopted by the company to this end.
While there is no universal ESG reporting standard, there is a whole range of frameworks, voluntary standards, and legislation that exist. This means that companies are afforded a lot of freedom when it comes to selecting the standard that suits them best. However, this can also make it difficult for stakeholders to understand and compare the ESG performance of different companies.
Generally speaking, ESG reports will cover a wide variety of ESG considerations, including the following.
ESG reports serve as comprehensive documentation of a company's sustainability initiatives and performance, which are then synthesised and evaluated to determine a company’s ESG score.
An ESG score, also referred to as an ESG rating, is an essential measurement of the environmental, social, and governance (ESG) efforts taken by a company. The ESG scoring assigns a quantitative metric (such as a numerical or alphabetical score) that allows stakeholders to compare the ESG performance of different organisations.
ESG scores are usually assigned by third-party providers and depending on the provider, different criteria may be used to score a company.
An ESG score or rating not only allows a company to measure the success of its ESG practices, but is also used by investors, analysts, and a variety of other stakeholders to assess the risks and opportunities arising from a company’s business operations. It also enables stakeholders to compare an organisation with competitors within the same industry or sector.
ESG scores a useful for a number of reasons:
There are a variety of third-party providers when it comes to ESG scoring. ESG rating agencies are hired by companies to perform an in-depth analysis of their ESG practices, which then allows them to identify areas to improve on, and to implement more effective ESG policies.
Additionally, companies may also choose to adopt an internal scoring process based on a standardised ESG framework such as the Task Force on Climate-Related Financial Disclosures (TCFD) or the Global Reporting Initiative (GRI).
Some of the most well-known third-party providers that you’ve probably already heard of include:
👉 To learn more about the Global Reporting Initiative and how to implement it in your own company, see our article. You can also learn more about the Task Force on Climate-Related Financial Disclosures here.
ESG scores, representing Environmental, Social, and Governance factors, are determined differently by various rating firms, each using their unique algorithms and criteria. These scores commonly stem from multiple sources including securities filings, voluntary business disclosures, governmental databases, academic research, and even media narratives.
👉 Any information that a business has made available through voluntary disclosure frameworks like the Global Reporting Initiative, the Carbon Disclosure Project (CDP), and the United Nations Sustainable Development Goals can also be used.
The data collected is segmented into scores for environmental, social, and governance criteria, which are subsequently combined into a comprehensive ESG rating.
While the format of ESG ratings may vary - be it a numerical score, a letter grade, or a categorical descriptor - they can generally be grouped into the following categories:
ESG scores help investors understand a company's practices, from employee treatment to decision-making and environmental priorities. Companies with good ESG scores often face fewer risks, attract better talent, and maintain strong stakeholder relationships and a solid reputation. This can enhance a company's profitability in the long run.
The ESG ratings market is rapidly growing, however, concerns have been raised over the reliability of ESG ratings and scores. With so many ESG rating firms on the market, and without any standardised ESG rating framework, how can stakeholders be sure that scores accurately reflect a company’s ESG practices?
In response to this growing concern, a number of countries and institutions are now looking into the regulation of the ESG ratings market:
Third-party ESG rating firms are not directly regulated in the UK, however, this could soon be about to change. In July 2023, the UK Government announced that ESG rating firms in the UK will face a new voluntary code of conduct. This comes ahead of potential mandatory regulations for the sector.
The code covers the governance of ESG ratings firms, alongside their systems and controls. It aims to ensure that ESG ratings are accurate and that methodologies are transparent.
👉 The UK Government is currently consulting on whether or not ESG rating firms should be formally regulated. ESG rating firms in the UK can expect to see regulation within the sector expand.
There is currently no regulatory regime when it comes to ESG rating firms in the US, however, there are growing calls for the US Securities and Exchange Commission to regulate the sector. Critics argue that ESG ratings are not sufficiently transparent and that varying ESG criteria make comparisons between companies difficult.
👉 Even though there is no sign that the SEC will take steps to regulate ESG rating firms, the SEC has proposed rules to enhance and standardise climate-related disclosures for investors. This would mandate certain climate-related disclosures in the periodic reports of public companies.
In June 2023, the European Commission published a sustainable finance package. Part of this package includes a proposal for regulation over the EU’s ESG rating activities. The proposed regulations would apply to ESG rating providers operating in the EU.
ESG rating firms that fall under the scope of the proposed regulations would be subject to authorisation granted by the European Securities and Markets Authority.
The proposed regulations would improve the transparency of ESG ratings criteria and methodologies by necessitating the disclosure of such information. The regulations will also help to eliminate potential conflicts of interest and reduce instances of greenwashing.
👉 The EU’s proposal is currently going through the EU legislative procedure and will be reviewed by the European Parliament and the Council of the European Union.
Regulations are on the horizon for ESG rating agencies, but what does this mean for businesses? Is it a positive change?
While these regulations streamline processes for companies, they also set higher sustainability standards. However, it's a win-win. Strengthening trust in ESG ratings, which are integral to sustainable investing, is beneficial for all. The move towards clarity and against greenwashing only reinforces this trust.
At Greenly we can help you to assess your company’s carbon footprint, and then give you the tools you need to cut down on emissions. Why not request a free demo with one of our experts - no obligation or commitment required.
If reading this article has inspired you to consider your company’s own carbon footprint, Greenly can help. Learn more about Greenly’s carbon management platform here.
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