ESG Ratings Need Revamping

ESG is a set of criteria used to determine if a company is environmentally and socially responsible with measurable governance in place. Companies who have adopted ESG policies and have an authentic culture do well, hence, the increased interest from investors as their financial performance is impressive.??However, there is controversy regarding ESG criteria and how they are being applied to the extent where ESG is questioned whether it truly makes a difference in restoring social and environmental balance. Furthermore, there are accusations of greenwashing particularly with rating agencies in the media. Maybe we need to reconsider how it is being measured rather than discard ESG altogether.

There is much at stake in the pursuit of ESG and for companies to implement ESG policies beyond seeking financial returns. ??The global objective for climate change is to protect the planet for our children’s future and other living beings. It's imperative that organizations of all sizes and individuals are engaged.?Company’s must survive, thrive and ultimately be resilient for the long term.?The pandemic certainly highlighted organizations, governments, and other institutions lack of preparedness culminating in a disastrous fallout globally.?Supply chains around the world were affected causing many to reassess local procurement and to reduce their carbon footprint. ?Also, Millennials and Gen Z are more socially conscious and savvy with social media and are eager to have their voices be heard; so, companies that ignore their concerns do so at their own peril. ?Attracting and retaining good talent is difficult at the best of times, so those who focus on ESG will have a competitive edge. Implementing ESG well will guide companies into making better decisions and de-risking the business; a win-win for all stakeholders.

There are many rating agencies e.g., MSCI, Sustainalytics, S&P etc. each having a unique way of scoring companies ESG.?There is much debate as the ratings often differ among these agencies.?The challenges sited are lack of transparency in the formulas and methodologies used to derive ESG scores, sources of data used, and the absence of standardizations.?This impacts the investor’s ability to render an informed decision regarding companies ESG initiatives.?Much has been written on ESG reporting being fraught with greenwashing.?ESG RATINGS

The need to improve ESG reporting requirements has been widely recognized. As of January 2023, Corporate Sustainability Reporting Directive (“CSRD”) is the European Union’s introduction of new rules to address this.?It impacts not only the EU but public and private non-EU companies doing business in Europe (phased over a period of time).?This will include nonfinancial reporting obligations on broader range of ESG topics. ?Under the Environment they consider climate change, pollution, water and marine sources, resource and circular economy, biodiversity, and ecosystem.?Under Social there are sections on workforce, workers in the value chain, affected communities, consumers, and end users, whereas Governance covers governance, risk management, internal controls, and business conduct.?The US in comparison has a limited move toward expanding ESG reporting obligations which concentrate on climate change and cybersecurity reporting rules. Regardless, what is becoming more evident is the need for oversight to move beyond corporate governance committees towards audit and compliance committees at the minimum.

Beyond rating agencies, there are many solution providers solving for the discrepancies that exist today. An organization called Triple Bottom Line has a contest called Better World Prize showcasing a number of ESG measurement solutions whose videos are presented here: BETTER WORLD PRIZE (Full Disclosure True Alpha is one of these solutions in which I have equity). True Alpha’s ESG investment management platform empowers small- and mid-sized asset managers to create ESG investment products and quantitatively report on the sustainable impact of their investments. TRUE ALPHA

Finally, companies need a holistic and consistent approach to ESG.?This tends to be easier for early-stage companies than for those more established.?How often do innovation in developing countries leapfrog those in developed countries particularly in industries where heavy investment has been made e.g., telecommunication.?The advantages of embedding ESG in the heart of the business at the outset are multifold as employees are engaged and inspired by their company’s mission, customers repeatedly purchase goods and services from companies they believe in, with financial returns that are often sustainable e.g., Patagonia. Companies who prioritize ESG not only are in an enviable position, they also create long term value.?Most importantly, tying ESG to the company's vision and purpose is critical, otherwise it becomes a wish list. For larger corporations, it’s never too late, starting with a transition plan rather than just having a PR strategy for appearance’s sake.?Let’s make ESG a priority.