Impact of ESG
ESG Scoring - How ESG is rated and scored within companies
- Most international and domestic public (and many private) companies are evaluated and rated on their environmental, social and governance (ESG) performance by various third party providers of reports and ratings.
- Listed below are short overviews and analysis of some of these providers.
- The Dow Jones Sustainability World Index (DJSI) - Launched in 1999, DJSI was the first global index to track sustainability-driven public companies based on RobecoSAM’s ESG analysis. S&P Dow Jones Indices has partnered with RobecoSAM for publication and calculation of ESG indices. DJSI is broken down into: DJSI World (tracking the world’s leading companies), DJSI Regions and DJSI Country. Out of 10 Industry Group Leaders listed on the 2016 DJSI, all 10 companies published a press release regarding this listing.
- S&P 500 ESG Index (Cboe Markets) - An ESG Index designed to improve ESG representation, while offering a risk return profile very similar to that of the S&P 500.
- Bloomberg ESG Data Service - In 2009 Bloomberg acquired New Energy Finance, which provides information regarding renewable energy and the carbon market, and subsequently launched Bloomberg ESG Data Service. Bloomberg collects ESG data for over 10,000 publicly-listed companies globally. ESG data is integrated into Bloomberg Equities and Intelligence Services. Bloomberg ESG Disclosure Scores rate companies annually (scored out of 100) based on their disclosure of quantitative and policy-related ESG data. In 2016, Bloomberg had over 12,200 ESG customers, providing ESG data to mainstream investors worldwide.
- ISS Quality Score- ISS provides a suite of ESG solutions to enable institutional investors to develop and integrate responsible investment policies and practices into their investment decisions. In 2015, ISS acquired Ethix SRI Advisers and formed a strategic partnership with RepRisk allowing ISS to further expand the ESG and socially responsible investing (SRI) research it provides. ISS developed the 'ISS QualityScore', which provides in-depth research on corporate governance on over 5,600 publicly-traded companies globally. Rated on a scale of 1-10, 1 indicating relatively higher quality governance practices and relatively lower governance risk, and 10 indicating relatively higher governance risk, the score is updated on an ongoing basis.
- MSCI ESG Ratings - Launched in 2010, MSCI ESG Research is one of the largest independent providers of ESG ratings. As part of the MSCI Group, they provide ESG ratings for over 6,000 global companies and more than 400,000 equity and fixed income securities. The MSCI ESG Rating is designed to measure a company’s resilience to long-term, industry material environmental, social and governance (ESG) risks. The system uses a rules-based methodology to identify industry leaders and laggards according to their exposure to ESG risks, and how well they manage those risks relative to peers. ESG Ratings range from leader (AAA, AA), average (A, BBB, BB) to laggard (B, CCC). Also rated are equity and fixed income securities, loans, mutual funds, ETFs and countries. Companies are systematically monitored and reviewed. New information is reflected in updates in reports on a weekly basis. In-depth company reviews occur at least annually. Companies are also invited to participate in a formal data verification process prior to publication of their ESG Ratings report.
- Sustainalytics Company ESG Reports - Sustainalytics is the 2008 consolidation of DSR (Netherlands), Scoris (Germany) and AIS (Spain). Sustainalytics now covers over 6,500 companies across 42 sectors and has an international presence. Sustainalytics' ESG Risk Ratings are used as a key metric for borrower's and lender's sustainability performance. ESG Risk Ratings are designed to help identify and understand financially material ESG risks and how those risks might affect performance. Scores are rated out of 100, using sector/industry-based comparison.
- Some examples of other providers of ESG ratings and reporting include: RepRisk - provides ESG reports for more than 84,000 private and public companies in 34 sectors globally, Thomson Reuters ESG Research Data - provide ESG data on over 6,000 public companies, Corporate Knights Global 100 - publishes an annual index of the Global 100 most sustainable corporations in the world in their Corporate Knights magazine.
Factors and Core Drivers Influencing ESG Ratings
- DJSI — Scores are derived from RobecoSAM’s annual Corporate Sustainability Assessment (CSA) whereby 2,500 publicly traded companies are invited to participate in the CSA for possible inclusion in the DJSI World. An industry-specific questionnaire is sent to the participants covering relevant economic, environmental, and social factors. Topics such as Corporate governance, risk and crisis management, codes of business conduct, customer relationship management, policy influence, brand management, tax strategy, information security & cyber-security, privacy protection, environmental reporting, environmental policy & management systems, and operational eco-efficiency drive the index score.
- S&P 500 ESG Index — Companies involved in certain business practices (for example, those extracting or generating electricity from non-renewal energy sources such as thermal coal, those who produce tobacco or have sales of greater than 10% generated from tobacco or tobacco related products, and those involved in controversial weapons) are immediately excluded from the index.
- Bloomberg ESG data covers 120 environmental, social and governance indicators including: carbon emissions, climate change effect, pollution, waste disposal, renewable energy, resource depletion, supply chain, political contributions, discrimination, diversity, community relations, human rights, cumulative voting, executive compensation, shareholders’ rights, takeover defense, staggered boards, and independent directors. Bloomberg ESG rating will penalize companies for missing data.
- ISS analyzes over 200 factors, divided into four pillars: board structure, compensation/remuneration, shareholder rights, and audit & risk oversight. Depending on the governance standards in each region, the ISS voting policy, and the impact on governance practices, a specific weight will be placed on each factor. Specific factors include: for board structure (board and board committee composition, board practices, board policies, related party transactions and board controversies), for compensation/remuneration (pay for performance, non-performance based pay, use of equity, equity risk mitigation, non-executive pay, communications and disclosure, termination and controversies), for shareholder rights (one-share one-vote, takeover defenses and meeting and voting related issues) and for audit and risk oversight (external auditor and audit and accounting controversies).
- MSCI ESG Research looks at ~35 ESG key issues, divided into three pillars (environmental, social and governance) and ten themes: climate change, natural resources, pollution & waste, environmental opportunities, human capital, product liability, stakeholder opposition, social opportunities, corporate governance, and corporate behavior. Data is collected from the following sources: government databases; company disclosures; macro data at segment or geographical level from academic, government, and NGO databases.
ESG Strategy - Example Case, Sustainalytics
- Sustainalytics' ESG Risk Ratings can help companies and investors identify ESG issues that pose a financially-material risk, and help them assess the magnitude of that risk. Specifically the ESG Risk Ratings measures the degree to which ESG issues are putting a company's enterprise value at risk. This is known as measuring the magnitude of a company's unmanaged ESG risk. An important characteristic of the ESG Risk Ratings is that they represent an absolute measure of risk — e.g. the scores and ratings are comparable across different issues, companies and industries.
- ESG Risk Ratings are formed of two main dimensions - Exposure and Management. Exposure is a company's vulnerability or susceptibility to ESG risks. The industry a company operates in largely determines the ESG risks it faces. For example an oil and gas company will be highly exposed to environmental issues. In contrast, a consumer tech business would be more exposed to social issues such as privacy and data protection. The management dimension refers to actions taken by a company to manage a particular ESG issue. This can include a company's ESG programs and policies. For example, management indicators for Ocupational Health and Safety include external health and safety certifications, assessments, quantitative KPIs, etc. Sustainalytics' ESG Risk Ratings measure a company's unmanaged ESG risk for each material ESG issue. These scores are aggregated to give an overall rating. The lower the risk rating, the lower their overall risk of experiencing material financial impact due to ESG factors.
- Summary - An efficient ESG Strategy is enabled through helping customers define and manage so-called ESG risks. This in turn helps to identify the 'management gap' - the amount of manageable ESG risks that are not being managed effectively. Sustainalytics allow exposure and management scores for different ESG issues to be combined and compared to one another. Having a single 'currency' for risk enables investors to easily compare the ESK risk profiles of different companies across their portfolio, and allows companies to compare and contrast their performance against industry peers, as well as companies from other sectors.
- Materiality Analysis — Investors want to know that a company has diligently assessed the issues that will have the greatest impact on its finances and business continuity. Thus, a recommendation is to complete a simple materiality analysis if at all possible. Every company and industry has its own set of material issues. Ideally, each company determines what is material to its business based on its sector, culture, values, stakeholders, and business model.
- Social Topics — research shows that investors are scoring companies on their labor management practices and overall work environment, including health and safety, training and education, and diversity and inclusion. Investors are expecting companies to establish policies against the use of child labor and forced labor as well as policies and management systems that promote workforce diversity and inclusion and that keep workers safe and healthy. In most cases, investors are expecting measurable goals and milestones.
- Governance Topics - Investors remain interested in whether a company has a board committee focused on corporate social responsibility, as well as in the composition of the board as it relates to various diversity aspects such as race, gender, age, and professional experience and skills. We also see that investors have been looking at linkages between remuneration and compensation policies and processes and ESG or other non-financial targets, as well as transparency around payment philosophy and performance.
ESG Effect on Stock price
- Research analysis into the materiality of ESG factors for Equity portfolios showed the European and US MSCI ESG Index were both significantly affected by external factors, such as the European debt crisis of 2012.
- MSCI KLD 400 Social index, focusing on 400 US firms which score highly in ESG terms, has generated annualized returns of 9.8% over the last 25 years against 9.6% for a wider universe of US stocks.
- Bottom 20% of ESG Stocks experience large drawdowns three times more than top 20% stocks.
- A research paper by MSCI Inc. led to the conclusion that ESG downgraded companies experienced a relative increase in both systematic and stock-specific risk compared to companies whose ESG rating was upgraded.
- Research found buying the top 20 percent best-ranked ESG stocks and selling the 20 percent worst ranked ESG stocks would have generated annualized returns of 3.3 percent in North America and 6.6 percent in the Eurozone.
- Real-Time ESG Intelligence - real-time, current news coverage to give investors unbiased insight into a company’s ESG-related activities.