Key Takeaways

• The top five performance factors that positively or negatively impact the environmental (E) component of the ESG score are climate risk, carbon emissions, energy consumption, water usage, and waste & pollution.
• About 86% of companies are now producing sustainability reports that indicate climate-related risks that they are exposed to.
• In the ESG rating of companies, high E scores have been attributed to high emissions, which does not reflect the low-carbon trajectory required of these companies.

Introduction

• This report provides insights into the top five performance factors that positively or negatively impact the E component of the ESG score. It also highlights the people who provide the ESG score of a company, how the score is determined, and other related information.

Top Five Performance Environmental Pillar Factors of an ESG Score

Climate Risk

• Climate risk is fundamental to understanding the 'E' in ESG. Climate risk is one of the environmental issues that could affect economic growth. Previously, climate risk was addressed as a futuristic issue.
• However, the effects of climate change are materializing in present-day situations from "more extreme downpours and droughts to record heat." Compared to previous years, companies, ESG agencies, and market participants are paying more attention to this metric.
• According to a GreenBiz report, 86% of companies are now producing sustainability reports that indicate climate-related risks that they are exposed to.
• From this number, 82% of companies reported that regulatory transition risks due to climatic changes could impact productivity negatively. Another 79% also mentioned physical risks as having the same impact.
• Climate risk poses significant financial implications. In 2014, S&P estimated a 5.2% loss in real economic output for the US economy by 2100. However, present-day findings indicate significantly more dreadful implications.
• A company's creditworthiness in the long term is significantly influenced by climate change due to "potential losses in infrastructure and property." As such, a company that fails to plan for climate change adequately would face significant financial implications, which would negatively reflect its ESG score in terms o sustainability.

Carbon Emissions

• In an attempt to restrict the global temperature rise by 2050 to 2 degrees Celsius higher than pre-industrial levels, almost every country adopted the Paris Agreement in 2015 to address the negative impacts of climate change.
• Carbon emissions due to the burning of fossil fuels that help to generate electricity, aid transportation, and provide heating, are a major contributor to changes in the climate. As such, there is a drive towards reducing greenhouse gas emissions.
• Notable shifts among companies include energy efficiency improvement and the adoption of renewable energy, among others.
• More companies have shifted from using coal to natural gas as a source of energy, providing an 85% more efficient means of producing electricity.
• However, in the ESG rating of companies, high E scores have been attributed to high emissions, which does not reflect the low-carbon trajectory that is required of these companies.
• It also indicates that "the E score in its current form is not an effective tool to differentiate between companies’ activities related to outputs that affect the environment, climate risk mitigation to improve risk-adjusted returns and medium-term strategies to align portfolios with lower-carbon activities."

Energy Consumption

• Energy use has been identified as the most relevant factor when considering environmental sustainability, as it is a direct contributor to the emission of greenhouse gases and other harmful compounds.
• Energy efficiency improvements have significant positive financial implications for companies in terms of production and distribution processes. It reduces the volatility of fossil fuel prices and can increase the value of fixed assets.
• As a result, more companies are implementing alternate, renewable energy sources, including solar and wind power, as part of their energy strategy.
• One such company, Kellogg, has reduced its absolute energy consumption by 8%. By 2050, Kellogg plans to reduce its emissions and those of its suppliers by 65% and 50%, respectively.
• ESG rating providers are introducing relevant metrics relating to energy consumption, such as energy efficiency and renewable energy strategies.
• For companies in high emission industries, a high energy consumption rate might not impact the overall E score negatively.

Water Usage

• Water is considered a key metric affecting the E component of a company's ESG score because of its daily usage across several industries.
• Subsequently, water consumption and stress have significant environmental impacts, including water scarcity for aquatic organisms due to depletion, malnutrition, and reduced crop yield.
• ESG scores consider a company's loss of water from faulty pipes/distribution lines in addition to its consumption/usage. According to Refinitiv, water efficiency policies increased in adoption by 25% over the past year among companies to 56% of companies who now employ the same.
• However, Sustainalytics provided that only 13% of companies report their water consumption. The report indicated that this low reporting rate might be due to a lack of awareness of water scarcity and its business impact.
• For many ESG rating agencies, failure to provide the necessary performance metrics results in a lower ESG score.

Waste & Pollution

• Waste management and pollution control have been considered a public duty for thousands of years. As such, it is a fundamental performance metric considered when providing a company's ESG rating.
• Waste management is broad and can be separated into food, animal, medical, and agricultural waste, among others. It is relevant in a large number of industries.
• However, according to MSCI's key metrics, pollution and waste cover toxic emissions and waste, electronic waste, and packaging material and waste.
• Waste production is often a byproduct of industrialization. Since industrialization cannot be stopped, companies with good waste management policies often receive a positive ESG score for the E component.

Who Determines a Company's ESG Score?

• Several agencies, research and analytics firms, and other third-party organizations such as Bloomberg, Thomas Reuters, RepRisk, and Dow Jones conduct company evaluations to provide an ESG rating/score.

How is the Score Determined?

• The agencies provide an ESG Score for a company by leveraging publicly available information and/or contacting the company directly.
• When analyzing only publicly available information, the agencies might rely on information received from stakeholders and other public sources, while negating self-disclosures from the company.
• Agencies that utilize public and direct company information when providing an ESG rating give a lower score to companies unable to provide the necessary information required for scoring.

Considerations for the Environmental Component

• The overall ESG score considers environmental, social, and governance ratings individually. However, there are specific considerations for each category.
• When scoring the environmental component of a company, agencies consider how the company's business and impacts greenhouse gas emissions, animals, water, plants, etc.
• Although there are several categories to consider under this component, a report by the Organisation for Economic Co-operation and Development (OECD) provides a few core categories as assessed by Bloomberg, Thomson Reuters, and MSCI.
• They include "energy, resource, and water use/intensity, ecology & biodiversity, waste management & output, emissions & carbon footprint, and renewable energy & climate mitigation."
• The agencies often evaluate these categories and their subcategories using an "input-output-outcome-process" chain. The inputs could be resource use, outputs could be emissions and waste, outcomes could be ecology and biodiversity, and the processes evaluated could be governance, strategy, and risk management.
• For any company, however, the evaluating agency always considers the industry where it operates to exclude what is not relevant and vice-versa.
• Lastly, every ESG rating agency has its unique rating system and approach to scoring a company.

The Most Commonly Accepted Protocols For ESG

• Based on the protocols/frameworks most frequently mentioned in stock exchange ESG guidance, the most commonly accepted protocols for ESG include the Global Reporting Initiative (91%), International Integrated Reporting Council (75%), Sustainability Accounting Standards Board (73%), and Carbon Disclosure Project (66%).
• Other protocols include the Taskforce on Climate-related Financial Disclosures (48%) and Climate Disclosure Standards Board (21%).

Top ESG Consultants

• Sustainalytics - Sustainalytics provides ESG ratings for 20,000 companies in 172 countries globally.
• MSCI ESG Research - MSCI ESG Research is an industry leader and provider of ESG ratings to over 14,000 fixed income and equity users.
• Bloomberg - Bloomberg ESG Disclosure Scores serve 100 countries globally, providing ESG data on over 11,000 companies.
• FTSE Russel - FTSE Russel provides ESG rating information on over 7,200 securities in 42 countries.
• Standard & Poor’s Global - S&P Global provides ESG scores for over 11,000 companies.
• Moody’s ESG Solutions Group - Moody's is credited for having carried out over 13,000 ESG assessments globally. It is also among the largest credit rating agencies globally.

Top ESG Tracking Software

• According to Capterra and Getapp, the best sustainability software for tracking ESG data is Cority.

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