Inside ESG Ratings: How Companies are Scored
Back in 1972, environmental, social, and governance (ESG) investing had a long way to go.
At the time, ESG research was a nascent field, but it paved the way for the booming investment strategy. Now, it is estimated that one in every three investments in the world will be ESG-mandated by 2025—with assets projected to reach $53 trillion.
This infographic from MSCI shows what’s behind a company’s ESG rating, and where the expansive universe of data comes from.
The ESG Data Universe
Drawing on over 1,000 data points, MSCI ESG Research collects data from a variety of sources:
- Company filings: Proxy reports, sustainability reports, shareholder results, voluntary company ESG disclosures
- NGOs: Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), UN Sustainable Development Goals
- Government: U.S. Environmental Protection Agency, European Central Bank, EU Taxonomy
- Media sources: Major headlines
- Alternative data: Geo mapping, water scarcity data, flood risk analysis
Across the expansive data frontier, these are just some of the sources that are drawn on. Typically, a significant amount of data goes beyond what a company will voluntarily provide.
ESG Ratings: The Two Fundamental Questions
During this process, there are two key questions that underlie ESG ratings:
- Which ESG issues could cause harm to investors?
- Which ESG issues may create opportunities, relative to their peers?
To answer these, MSCI uses a combination of technology and ESG analysts.
Next, a company-specific score is calculated based on three pillars. Here is a snapshot of some of the key issues that fall within each of the E, S, and G pillars:
|Climate Change||Human capital||Corporate governance
|Pollution & Waste||Stakeholder opposition||Corporate behavior
|Environment opportunities||Social opportunities|
So how does this break down for a specific company?
Case Study: Oil & Gas Company
Harnessing artificial intelligence, an ESG analyst looks at a petroleum company to assess its impact on sustainability through a top-down approach. They focus on the most relevant issues including:
Tons of CO2 emitted/$ million annual sales
Indigenous Rights Policy
Executive compensation structure
|Pollution & waste:|
Tons of CO2 emitted/$ million annual sales
|Supply-chain labor standards:|
Partnering with a diverse set of suppliers on sustainability issues
Spills, notice of violations, compliance fines
Importantly, this shows just a snapshot of the process, while ESG analysts do the heavy-lifting.
The ESG Ratings Scorecard
Finally, based on a thorough analysis of the most relevant themes and issues facing a company, a final score is assigned. Companies are grouped according to three primary tiers:
|CCC, B||BB, BBB, A||AA, AAA|
These scores can influence investor decisions on many levels:
- Investors can prioritize a company’s resilience to unanticipated and financially damaging ESG risks.
- Ratings provide a launching point for shareholder engagement on ESG performance and how investment products are created.
- Investors can find opportunities in new and existing markets.
- Investors can make informed ESG decisions in the medium and long term.
Why Do ESG Ratings Matter?
Today, investor demand is one of the chief drivers of ESG investing.
Alongside this, reputational benefits and higher risk-reward tradeoff are playing a larger role in how investors think about sustainability and their investments. But of course, ESG ratings alone are not the entire picture.
By combining ESG ratings and traditional financial analysis, investors can put together a more discerning picture of a company’s risks and opportunities.
Green Investing: How to Align Your Portfolio With the Paris Agreement
MSCI’s Climate Paris Aligned Indexes are designed to reduce risk exposure and capture green investing opportunities using 4 main objectives.
Green Investing: The Paris Agreement and Your Portfolio
In Part 1 of the Paris Agreement series, we showed that the world is on track for 3.5 degrees Celsius global warming by 2100—far from the 1.5 degree goal. We also explained what could happen if the signing nations fall short, including annual economic losses of up to $400 billion in the United States.
How can you act on this information to implement a green investing strategy? This graphic from MSCI is part 2 of the series, and it explains how investors can align their investment portfolios with the Paris Agreement.
Alignment Through Indexing
When investors are building a portfolio, they typically choose to align their portfolio with benchmark indexes. For example, investors looking to build a global equity portfolio could align with the MSCI All Country World Index.
The same principle applies for climate-minded investors, who can benchmark against MSCI’s Climate Paris Aligned Indexes. These indexes are designed to reduce risk exposure and capture green investing opportunities using 4 main objectives.
1.5 Degree Alignment
The key element is determining if a company is aligned with 1.5 degree warming compared to pre-industrial levels. To accomplish this, data is collected on company climate targets, emissions data, and estimates of current and future green revenues. Then, the indexes include companies with a 10% year-on-year decarbonization rate to drive temperature alignment.
Environmentally-friendly companies may have promising potential. For instance, the global clean technology market is expected to grow from $285 billion in 2020 to $453 billion in 2027. The MSCI Climate Paris Aligned Indexes shift the weight of their constituents from “brown” companies that cause environmental damage to “green” companies providing sustainable solutions.
Some companies are poorly positioned for the transition to a green economy, such as oil & gas businesses in the energy sector. In fact, a third of the current value of big oil & gas companies could evaporate if 1.5 degree alignment is aggressively pursued. To help manage this risk, the indexes aim to underweight high carbon emitters and lower their fossil fuel exposure.
Climate change is causing more frequent and severe weather events such as flooding, droughts and storms. For example, direct damage from climate disasters has cost $1.3 trillion over the last decade. MSCI’s Climate Paris Aligned Indexes aim to reduce physical risks by at least 50% compared to traditional indexes by reducing exposure in high-risk regions.
Together, these four considerations support a net zero strategy, where all emissions produced are in balance with those taken out of the atmosphere.
Green Investing in Practice
Climate change is one of the top themes that investors would like to include in their portfolios. As investors work to build portfolios and measure performance, these sustainable indexes can serve as a critical reference point.
Available for both equity and fixed income portfolios, the MSCI Climate Paris Aligned Indexes are a transparent way to implement a green investing strategy.
Decarbonization 101: What Carbon Emissions Are Part Of Your Footprint?
What types of carbon emissions do companies need to be aware of to effectively decarbonize? Here are the 3 scopes of carbon emissions.
What Carbon Emissions Are Part Of Your Footprint?
With many countries and companies formalizing commitments to meeting the Paris Agreement carbon emissions reduction goals, the pressure to decarbonize is on.
A common commitment from organizations is a “net-zero” pledge to both reduce and balance carbon emissions with carbon offsets. Germany, France and the UK have already signed net-zero emissions laws targeting 2050, and the U.S. and Canada recently committed to synchronize efforts towards the same net-zero goal by 2050.
As organizations face mounting pressure from governments and consumers to decarbonize, they need to define the carbon emissions that make up their carbon footprints in order to measure and minimize them.
This infographic from the National Public Utility Council highlights the three scopes of carbon emissions that make up a company’s carbon footprint.
The 3 Scopes of Carbon Emissions To Know
The most commonly used breakdown of a company’s carbon emissions are the three scopes defined by the Greenhouse Gas Protocol, a partnership between the World Resources Institute and Business Council for Sustainable Development.
The GHG Protocol separates carbon emissions into three buckets: emissions caused directly by the company, emissions caused by the company’s consumption of electricity, and emissions caused by activities in a company’s value chain.
Scope 1: Direct emissions
These emissions are direct GHG emissions that occur from sources owned or controlled by the company, and are generally the easiest to track and change. Scope 1 emissions include:
- Company vehicles
- Chemical production (not including biomass combustion)
Scope 2: Indirect electricity emissions
These emissions are indirect GHG emissions from the generation of purchased electricity consumed by the company, which requires tracking both your company’s energy consumption and the relevant electrical output type and emissions from the supplying utility. Scope 2 emissions include:
- Electricity use (e.g. lights, computers, machinery, heating, steam, cooling)
- Emissions occur at the facility where electricity is generated (fossil fuel combustion, etc.)
Scope 3: Value chain emissions
These emissions include all other indirect GHG emissions occurring as a consequence of a company’s activities both upstream and downstream. They aren’t controlled or owned by the company, and many reporting bodies consider them optional to track, but they are often the largest source of a company’s carbon footprint and can be impacted in many different ways. Scope 3 emissions include:
- Purchased goods and services
- Transportation and distribution
- Employee commute
- Business travel
- Use and waste of products
- Company waste disposal
The Carbon Emissions Not Measured
Most uses of the GHG Protocol by companies includes many of the most common and impactful greenhouse gases that were covered by the UN’s 1997 Kyoto Protocol. These include carbon dioxide, methane, and nitrous oxide, as well as other gases and carbon-based compounds.
But the standard doesn’t include other emissions that either act as minor greenhouse gases or are harmful to other aspects of life, such as general pollutants or ozone depletion.
These are emissions that companies aren’t required to track in the pressure to decarbonize, but are still impactful and helpful to reduce:
- Chlorofluorocarbons (CFCs) and Hydrochlorofluorocarbons (HCFCS): These are greenhouse gases used mainly in refrigeration systems and in fire suppression systems (alongside halons) that are regulated by the Montreal Protocol due to their contribution to ozone depletion.
- Nitrogen oxides (NOx): These gases include nitric oxide (NO) and nitrogen dioxide (NO2) and are caused by the combustion of fuels and act as a source of air pollution, contributing to the formation of smog and acid rain.
- Halocarbons: These carbon-halogen compounds have been used historically as solvents, pesticides, refrigerants, adhesives, and plastics, and have been deemed a direct cause of global warming for their role in the depletion of the stratospheric ozone.
There are many different types of carbon emissions for companies (and governments) to consider, measure, and reduce on the path to decarbonization. But that means there are also many places to start.
National Public Utilities Council is the go-to resource for all things decarbonization in the utilities industry. Learn more.
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