What is the Environmental, Social, and Governance Criteria? (And How Would Your Business Score?)

Written By YellowBird
December 28, 2021

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A company's environmental, social, and corporate governance (ESG) score describes its perceived performance on environmental, social, and governance topics to consumers. The issues can be materially important to a company's stakeholders and compelling for other non-financial reasons.

An ESG score is how the public perceives an organization’s performance in relation to certain factors. If a company handles a situation or topic that isn't available to the public, it doesn't impact their ESG score.

What is the brief history of the ESG?

The ESG criteria were first mentioned in 2006 within the United Nations Principles for Responsible Investment (PRI) report. This was the first time ESG criteria were required to be incorporated in the financial evaluations of an organization. The purpose behind including these criteria was to spark further development of sustainable investments.

What is its purpose?

ESG — Environmental, Social, and Governance — are the three broad areas of interest for socially responsible investors that make investment decisions based on their values. They typically tend to support companies they can feel morally good about being involved with.

Business Wire reported that 68 percent of those surveyed stated the implementation of ESG criteria has aided in improved returns on their investments. In this study, they also found that 77 percent of those surveyed said they invested in strategies related to ESG directly due to the strategies' impacts on a public company's financial gains.

The Environmental Factors

What business aspects and relations fall under the environmental criteria?

Environmental criteria can include the amount of energy used by a company, the amount of waste or pollution produced, how much they're doing to conserve natural resources, their treatment of animals, and more. ESG criteria are often used to evaluate the environmental risks a company may face and how they manage those risks.

For instance, environmental issues could include contaminated land a company owns due to their irresponsible disposal of hazardous waste, the release of toxic emissions into the air, and more. They could also include how compliant a company is with environmental regulations imposed by government policy.

Why are environmental factors important today?

Consumers are increasingly concerned with how companies handle their environmental footprint. Investors and stakeholders are aware of this impact, effectively demanding that businesses make concerted efforts to be environmentally conscious and friendly.

The Social Factors

What business aspects and relations fall under the social criteria?

The social criteria concern the business's relationships with other companies, employees, and its local community. This includes having a high regard for employee working conditions, donating to the local community, and working with other businesses that hold similar values.

This means taking the initiative to achieve and exemplify a business's claimed goals and values, not merely just stating them on paper or during press releases. Companies have to prove they stand for their values with meaningful action, and their score reflects that.

The Corporate Governance Factors

What business aspects and relations fall under the corporate governance criteria?

Governance criteria refer to how a business operates and includes many different categories. For example, investors may prefer to only work with companies that use transparent accounting methods or where they can vote on company issues or board members.

This is about identifying and trusting the integrity of a business as well as its operations and motivations.

How Are Businesses Graded?

How are ESG scores calculated?

Businesses usually get their ESG scores calculated by a third-party evaluation company that uses its own methodologies for reaching an ESG score.

Most of the largest ESG rating providers source this data from publicly available information as well as through direct contact with the company.

It's important to remember that most ESG scoring agencies only include factors that are relevant in a company's industry when calculating their score.

What is the rating scale?

The rating scale varies from agency to agency. Some of the giants, like Bloomberg, use a 100-point scale, while Thomas Reuters uses 0-1 with letter grades. Others score from AAA to D. To accurately review a company's ESG score, you must first understand how their rating scale works.

Is this grade something to seriously worry about?

ESG rating is the public perception of a company. Some investors believe the ESG criteria is critical beyond indicating ethical values, with a low score being a risk sign for potential financial loss.

What ramifications does it have on a business?

The ramifications can be severe as the public's perception of a business will almost assuredly have a substantial impact on a company's success. A lower ESG rating indicates a company isn't doing things as well as it could be. This highlights that it has room to improve if it wants to remain competitive in the market and not fall behind competitors or become defunct.

Why Improving Your ESG Rating Matters

ESG ratings are becoming more of a topic of conversation among investors, consumers, and stakeholders. Individuals and groups are becoming more aware and concerned about the environmental, social, and internal standing and behavior of the businesses they support and stand behind.

ESG ratings can be used in the projection of future success. Conversely, a low ESG rating can indicate a risk of poor performance or impending disaster on the horizon for stakeholders.

ESG investing, despite the criticisms, is becoming increasingly popular and is most likely to be an investing approach used by millennials. Morgan Stanley Bank (NYSE: MS) recently conducted a survey that found that nearly 90% of millennial investors were interested in pursuing investments that more closely reflect the values they hold.

How can businesses be more conscious of their ESG rating and improve it?

One answer includes hiring the help of environmental health and safety professionals. They can audit and recommend suggestions on ways to be more proactive in these related measurable areas. Moreover, hiring an outside auditor ensures there is no bias and you're receiving accurate results.

ESG consulting services provide organizations with the tools and knowledgeable team they need to improve ESG ratings. Additionally, global ESG disclosure frameworks help to bolster standardized reporting, which has played a key role in producing consistent and comparable information for investors.

The London Stock Exchange has compiled a list of the seven characteristics that they call "investment grade" data in which they believe all companies collecting ESG data should try for. These seven characteristics are:

  • Accuracy
  • Boundaries
  • Comparability and global consistency for ease of comparison
  • Data provision that provides raw data along with normalized data
  • External data assurance
  • Timeliness of data coinciding with the annual reporting cycle
  • Balanced and objective view, which includes both favorable and unfavorable information about a company

How to find your ESG score

One of the easiest ways to find your ESG score is to check with an ESG monitoring company. You'll usually have to create an account and input your business information so they can send you your business's score.

Another method is through major financial institutions you may have an account with. Firms like Meryl Lynch include your business ESG score along with other account information and business details.

Knowing your company's ESG score can be a great step in boosting your company's rating and value among investors, stakeholders, and consumers alike.

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