The term ESG score refers to the measurement of an organisation’s sustainability and ethical impact through differing environmental, social and governance objectives and criteria. The disclosure of ESG scores provides stakeholders insight into issues that are not usually accounted for in a company’s financial statements but have an important contribution to its long-term performance and potential.
The growing importance of sustainable corporate practices has seen ESG scores grow in popularity across industries and play an increasingly important role in workplace decisions. In fact, a 2021 report from the Governance and Accountability Institute found that of the 500 S&P companies, over 90% actually have some form of ESG reporting in place. In Australia, ASIC is increasing its pressure on company directors to manage non-financial risks, as well as the usual financial risks, and this aligns with some of the components of ESG – particularly the social and governance aspects.
As the components of ESG continue to gain prominence, with everything from carbon emissions to labour practices gaining more scrutiny, it is vital that employers move wisely and make smart ESG decisions. Utilising ESG scores as a tool to guide your approach will help ensure that the organisation keeps up with the evolving expectations of stakeholders.
What does an ESG score measure?
An ESG score measures the performance of an organisation in relation to its ESG-related responsibilities. There are numerous factors taken into account when assessing how a company’s business practices are performing in each ESG category but common examples include; the health and safety of workers, air and water pollution, climate change, board diversity, clean technology and sustainability management.
Utilising ESG criteria to examine organisations offers valuable information not only to stakeholders but also to employers – a study conducted by Oxford University showed that in 90% of companies that made sustainability a priority, higher cash flowers were enjoyed and operation performance was also improved. Furthermore, a good ESG score helps the organisation to stand out amongst the competition and demonstrate its potential for greater long-term performance.
In total, there are several hundred ESG indicators and not all of them will necessarily be as important as each other or examined every time an ESG score is calculated. Some common examples of the factors are listed below under their relevant ESG pillar:
Environmental issues can include:
Social issues can include:
Governance issues can include:
How are ESG scores calculated?
ESG scores are calculated by third-party rating firms which utilise data from varying different sources, such as financial statements, government databases, securities filings etc, to make their judgement.
This includes any information that is available through frameworks such as the UN Sustainable Development Goals (SDGs) and Global Reporting Initiative (GRI) which provide valuable information about an organisation’s impact on ESG issues.
By utilising an unbiased third-party group, the risk of any manipulative influence on the score is minimised and stakeholders are able to place greater trust in the result. Each firm has its own method of scoring and investigating a company’s performance and operations and each factor is also given a different level of importance given its significance – typically, factors that have the potential for the greatest impact within a period of two years are given more importance.
Once a score has been calculated through a combination of algorithms and analysis for a particular factor it is then categorised and incorporated into the relevant environmental, social and governance scores. These scores are then eventually combined to form the final ESG rating.
Why are high ESG scores beneficial?
Companies with higher ESG scores are often more attractive to investors because they generally have lower exposure to potential future risks as well as fewer liabilities. ESG metrics are increasingly seen as markers for long-term potential success and as result, companies with higher ESG scores attract more investors. Furthermore, investors can place greater trust in the organisation’s operations and align more of their values together which helps build a better relationship between the two.
Customers are more like to purchase the products and services of organisations with higher ESG scores in reflection of their own personal values and desire to support sustainable and ethical businesses. As a byproduct, these companies also have a better reputation amongst consumers and are able to better retain their customer base.
3. Attracting talent:
ESG scores also help to attract talent to the organisation and retain it – research by Deloitte indicates that employees who are satisfied with their organisation’s societal and environmental impact are more likely to stay with the company in the long term.
4. Risk Management:
Companies with strong ESG scores are less likely to be impacted by environmental and social risks such as natural disasters, labour disputes, and community backlash. Additionally, companies with strong ESG scores are more likely to be in compliance with regulations, and less likely to face legal and financial penalties.
5. Financial performance:
Organisations that focus more on ESG issues tend to have better long-term financial performance, as they are more likely to be resilient in the face of economic and regulatory changes. This allows them to better face challenges without compromising their bottom line.
Companies that focus on ESG issues tend to be more innovative, as they are more likely to think creatively about how to reduce their environmental and social impact, while still achieving their business goals.
How can an organisation improve its ESG score?
To understand how to improve your ESG score, it’s important to first understand what is actually considered a good score and why. Many agencies assign an ESG score on a scale from zero to 100. Typically, a score of less than 50 is regarded as poor, while a score of more than 70 is considered excellent.
Ratings can also be assigned with letters (where CCC or C is the worst rating and AAA is the best) or described as either ‘excellent, good, average, or bad’. If your organisation’s ESG score is not one that you are satisfied with, an ESG strategy should be developed to help improve it. When doing so, key considerations to take into account include:
- How well are you meeting the requirements of any regulations you follow?
- What ESG risks is the company most vulnerable to?
- Are you taking ESG trade-offs into account when making any changes?
- What ESG-related issues are most relevant to your organisation and stakeholders?
- How will you maintain your bottom line whilst prioritising ESG within your operations?
- What ESG areas does the company need to improve on most?
- What are you doing to make sure your ESG framework will be able to handle future challenges and changes?
- How is your organisation monitoring your ESG prominence?
- What steps will you take to build your ESG strategy into your employee culture, policies, and procedures?
Whilst it’s necessary for every employer to ensure that ESG concerns are addressed, it’s important to keep in mind that ESG scores are not the sole measure of a company’s overall performance and should only be utilised in conjunction with various other metrics to make any key decisions.
Furthermore, the lack of a unified approach to ESG scoring and the differences between each agency’s approach to ratings has raised questions about a lack of transparency surrounding ESG grading criteria. It’s also difficult to assess the validity or reliability of a company’s ESG-related disclosure due to the lack of regulatory standards.
As such, whilst ESG scores offer valuable insight and information about an origination, they are not without fault and should be utilised cautiously and mindfully.
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To conclude, the business climate of today makes it necessary for employers to invest time and resources into ensuring that their ESG scores remain competitive. Failing to do so, can negatively impact the long-term growth and success potential of the company as well as its ability to attract investors, retain customers and manage risks.
With environmental, social and governance issues becoming increasingly complex and multifaceted, understanding what ESG scores are and how they operate is essential for ensuring that your origination is able to meet changing demands and remain competitive in the long term.