The importance of ESG raters and rankers lies in their ability to provide third-party evaluations of companies’ management over ESG risks and opportunities that could inform investors’ and other stakeholders’ decision-making processes in business engagement.
ESG scores designated from raters and rankers aid companies in referencing external recognitions to showcase their effectiveness in ESG management, which helps alleviate stakeholder concerns over ESG issues, highlight sustainability practices, and offer a competitive advantage. Being well-informed about ESG raters and rankers is crucial for companies seeking to navigate the ESG landscape and pursue opportunities in developing and/or expanding their ESG programs and communications.
What Are ESG Raters and Rankers?
ESG raters and rankers are specialized organizations that assess companies based on their ESG practices and assign them ESG scores or rankings. These organizations collect data from a variety of sources, including corporate disclosures, public records, and third-party data providers and media, to evaluate companies' sustainability performance.
There are several prominent ESG raters and rankers in the market, such as MSCI, Sustainalytics, ISS ESG, and CDP (formerly Carbon Disclosure Project). Each rater/ranker employs their own methodology and criteria to evaluate companies, focusing on a wide array of ESG factors like carbon emissions, diversity and inclusion, labor practices, corporate governance, and supply chain sustainability.
What Is the Difference Between an ESG Rating and an ESG Ranking?
ESG rating and ESG ranking are two approaches to assessing and comparing companies' environmental, social, and governance performance. While they share similarities, there are differences between the two.
ESG rating
ESG ratings provide a comprehensive evaluation of a company's ESG performance, allowing stakeholders to compare and benchmark companies within an industry or across sectors. Ratings often follow a standardized methodology and can be provided by specialized ESG rating agencies, financial services firms, or investment research institutions.
The output of an ESG rating is typically a score or grade (e.g., on a scale of 1 to 100 or a letter grade), reflecting the overall ESG performance of a company. Ratings may also include individual scores or assessments for different ESG categories.
ESG ranking
ESG rankings involve comparing companies' ESG performance and positioning them in a hierarchical order based on their relative ESG scores or ratings, creating a snapshot of benchmarked companies’ ESG practices. Rankings are focused on providing a simplified view of how companies perform against one another rather than presenting detailed results of ESG scores or grades.
ESG rankings are often presented in the form of league tables or lists, where companies are ranked from the highest to the lowest in terms of their ESG performance. These rankings allow stakeholders to quickly identify leaders and laggards within an industry or sector.
Benefits of Engaging with ESG Raters and Rankers
ESG ratings provide a platform for companies to communicate their sustainability efforts to stakeholders based on third-party assessment results, enhancing the credibility of their disclosures.
ESG ratings also play a vital role in investment decision-making. A strong ESG rating can attract investors who prioritize sustainable businesses, leading to increased access to capital and potentially lower borrowing costs.
Companies that put work into earning a strong ESG rating can differentiate themselves from their peers by showcasing their superior sustainability performance. This can attract customers who prefer sustainable products/services and help attract and retain top talent.
Pitfalls To Watch Out For When Working With ESG Raters and Rankers
While engaging with ESG raters and rankers has its advantages, companies should be aware of potential pitfalls.
Different raters and rankers adopt varying methodologies and assessment scopes, resulting in inconsistencies and discrepancies in ratings and making it challenging to benchmark companies within an industry from one single rating/ranking source. Companies need to understand the methodologies used by each rater/ranker and how they align with their own sustainability management and communication objectives.
Despite varying rating and raking schemes, companies should provide accurate and valid ESG information that is material to their businesses in order to be accurately assessed by raters and rankers.
Approaching ESG Reporting with an Eye to Rankings
Robust ESG reporting—providing high-quality, decision-useful ESG information and data on an organization’s sustainability performance—can help improve third-party ESG ratings and ranking. To optimize ESG reporting, companies should consider the following approaches.
Data accuracy and relevance
Companies should work to ensure their ESG data is accurate, reliable, and aligned with recognized reporting frameworks such as the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB). Relevant data points of company-specific material ESG topics should be prioritized to ensure the availability of meaningful information for ESG raters/rankers’ evaluations.
Stakeholder engagement
Engaging with stakeholders is crucial in identifying material ESG issues and demonstrating a commitment to addressing them. Regular communication and collaboration with stakeholders can provide valuable insights and help align a company’s ESG management and disclosure practices with stakeholder expectations.
Continuous improvement
ESG management and disclosure is an ongoing journey. Companies should consider setting meaningful ESG targets, tracking progress, and implementing initiatives to improve performance over time. Regularly reviewing and updating sustainability strategies demonstrates a commitment to continuous improvement.
The Emerging Role of AI in ESG Ratings
AI is playing an increasingly important role in ESG rating processes. AI-powered algorithms can analyze vast amounts of structured and unstructured data, including financial reports, news articles, social media sentiment, and satellite imagery. These algorithms can identify patterns, assess risks, and provide real-time insights into a company's ESG performance.
AI-driven ESG rating models aim to enhance the accuracy and efficiency of assessments. However, challenges related to data quality, biases in algorithms, and transparency in the rating process still need to be addressed. In preparation for the increasing adoption of AI-driven ESG ratings, it is recommended that companies ensure machine-readable ESG disclosures and data to support AI-based ESG assessments.
Working Toward Your Own ESG Rating
Engaging with ESG raters and rankers allows companies to communicate their sustainability efforts, appeal to socially responsible investors, and differentiate themselves in the market. By approaching ESG reporting with accuracy, investing in stakeholder engagement, and maintaining a commitment to continuous improvement, companies can optimize their ratings and rankings and strengthen their sustainability practices.
