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Sustainability is more than just a buzzword. These days, it’s top of mind for investors and consumers alike. People today will go out of their way to identify sustainable companies, and most are willing to pay more for their products.
As awareness grows, investors are pushing for a standard by which to gauge and assess performance through an ESG lens. Hence, many investment funds rely on ESG scores to inform their decisions.
Today, we’ll look at ESG scores, what they are, what they measure, why they matter, and how to separate the good from the bad.
ESG Scores Explained
ESG stands for environmental, social, and governance. When expressed as a score, it helps people identify issues that you won’t find described on the average company balance sheet but have a crucial impact on an organization’s economic and environmental sustainability.
The ESG score considers many factors, including how a company intends to respond to climate change and its energy policies.
It also includes the organization’s diversity, equity, and inclusion (DEI) strategy, human rights, and employee happiness.
While climate and energy policies might seem a more obvious metric, many studies show how critical employee happiness is to the bottom line. Less turnover helps companies maintain stability and reduces costs and risks associated with attracting and recruiting new employees.
Financial data is still essential, of course. However, the numbers hold more weight and provide a broader view of a company’s potential for forward-moving, sustainable growth when considered in the context of ESG.
ESG Scoring Companies
- Principles for Responsible Investment (PRI)
- Global Reporting Initiative (GRI)
- Sustainability Accounts Standard Board (SASB)
- EFRAG Sustainability Reporting Board
- International Sustainability Standards Board (ISSB)
Though these frameworks are voluntary, they are generally considered a way for companies to create value, reduce costs and organizational risk, and accelerate growth by demonstrating higher market and enterprise value.
Companies with strong environmental and social governance are seen as better choices for investors and funds. Considering today’s volatile market, even those with a higher risk tolerance may be rethinking their strategies. A higher ESG score may be pivotal in engaging investors and other stakeholders, while a low score may be a complete turn-off.
What Do ESG Scores Measure?
There are three categories that contribute to a company’s final ESG score—environmental, social, and governance.
- Vulnerability to climate impact
- Carbon impact and emissions
- Water usage and sourcing
- Greenhouse gas emissions
- Electronic waste
- Waste in general
- Land use
- Packaging materials used
- Waste produced from packaging
- Workplace health and safety policies
- Pay equity and living wage
- Employee benefits
- Compliance with labor standards
- Responsible supply chain
- Labor management
- Consumer protection policies
- Product safety
- Product quality
- Risk management
- Corporate governance
- Ethical practices
- Conflict of interest avoidance
- Accounting transparency
- Financial integrity
- Leadership compensation
- Board diversity and independence
How Are ESG Scores Expressed?
ESG scores are expressed using a scale of 1-100. Generally, a score of 50 or less is considered poor. Seventy and above is excellent. Scores may also be simply described as being poor, average, good, or excellent. Here’s what that means:
- Poor: no best practices identified. The company may be doing things that are harmful to the environment or treating its employees poorly.
- Average: companies are not actively working toward ESG goals.
- Good: the company meets best practice standards in all categories and has no negative impact on the planet.
- Excellent: all best practices are followed; the company has no internal or external problems.
Why ESG Scores Matter
It’s easy to see why ESG matters in the bigger scheme of things. Sustainability is a gauge of a company’s future and growth potential, showing the organization is prepared to meet oncoming challenges, whatever they might be.
To an investor, the ESG score might actually be a better way to gauge a company’s risk or what barriers they might face in the future. Using the ESG score to inform decisions makes those choices more straightforward, as companies that don’t meet the criteria can be quickly eliminated from consideration. It may also provide insight when deciding what to do with companies already in an investment portfolio if prioritization becomes an issue.
For companies, a high ESG score may make it easier to attract and retain top talent. Most in this category have a strong employee brand, excellent supplier relationships, and fewer liabilities all around.
ESG Scoring Limitations
Though ESG scores are highly informative, they should not be the only arbiter driving critical decisions. For one thing, the score is not yet standardized, there are no hard and fast rules, and there is a general lack of transparency regarding reporting.
Global agencies and regulators, including the Securities and Exchange Commission (SEC) in the US, are working to address these concerns to improve reporting accuracy for publicly traded companies. The Financial Conduct Authority (FCA) in the UK has also recently announced the formation of a group to oversee codes of conduct for ESG rating agencies. As these initiatives mature, transparency will undoubtedly grow, the methodology will become easier to understand and implement, and the ratings themselves will become more reliable.
Getting Started with ESG
ESG scoring is inextricably tied to sound business practices. Companies with a strong ESG posture tend to outperform their peers, sending value straight to the bottom line.
As with any evergreen initiative, ESG requires thoughtful assessment and long-range vision.
Ensure you and your team understand what ESG means and how the various factors relate to your business model.
Audit your operations through the ESG lens and identify areas of improvement in environmental, social, and governance categories.
Understanding where you want to be is the first step to creating a viable plan. Set specific goals and timelines and create an action plan to help you achieve them.
As you implement changes, measure your progress. Nothing happens overnight! If you notice some areas stalling out, adjust and get back on track.
ESG is a team effort. Ensure your team is on board and understands the changes you are trying to implement. Let your customers, investors, and other stakeholders know what you’re doing and why. Working together makes it easier to accomplish bigger things.