ESG ratings-main findings
While according to the “Rate the Raters”* report, developed by ERM’s SustainAbility Institute, raters face rising concerns from corporates and investors questioning data accuracy and the quality and practicality of ESG ratings, it is investor demand that primarily drives the engagement with ESG raters.
The report finds that 57% of companies claim investor demand to be their top motivation, followed by a performance assessment rating 21%, strategy development at 7%, and risk assessment at 6%.
Numbers indicate the growing integration of ESG ratings and data into investment strategies. From 12% noted in 2018/2019, to the current 43% of investor respondents ranked requirements by their firms to integrate ESG ratings and data into their investment practices as a top reason for using ESG ratings providers.
Major ratings concerns
What raises concerns is the disparity between the opinions of corporates and investors. While 29% of corporates have low to very low trust that ESG ratings accurately reflect ESG performance, and 52% have only moderate trust, investors on the other hand reported 59% moderate trust and 38% high to very high trust in ESG rating providers.
Interestingly enough, the survey also reveals a notable trend for investors to develop in-house ESG indicators, metrics, and ratings, which reflect the efforts investors have made in recent years to build their own ESG expertise. The main motivation given for introducing its own ratings is to make sure the whole portfolio is being weighted, and the same measures for private equity and public companies are being used. According to investors, such an approach fits better their needs than the ratings offered by outside ESG raters.
While across both investors and companies, around half see “greater consistency and comparability across ratings methodologies” and “improved quality and disclosure of methodology”, they list some key issues for ESG raters that require to be fixed in order to maintain trust.
Among major problems, there are:
- dynamics of sustainable investing environment, making it hard to keep up with,
- rapid growth in ESG funds and required company ESG performance examination,
- increasing ESG disclosure requirements and new regulations introduced varying between the US and different parts of Europe
- ranking inconsistencies,
- rating agencies making errors during their evaluation process, including incorrect analysis of company data, and producing inaccurate results, which companies would then have to contest,
- publishing ESG scores and reports with incomplete and incorrect metrics or not taking into consideration relevant corporate disclosures resulting in data needing to be adjusted to be correctly displayed in ratings.
It is true that each company sees its ESG program as something unique, and it is not possible 100% to fit into the criteria of rating providers, considering a variety of weightings, methodologies, and analyses being used.
According to Tom Reichert, ERM Group CEO: “We know first-hand how crucial ESG ratings are to spurring action on the sustainability agenda and ensuring the highest performing organizations get the recognition and financing they need. However, our survey shows that the ESG ratings industry is at a crossroads. How raters respond to the pressures they face will determine what the field looks like in the decade to come” (ESG News, 2023).
Recommendations
On a positive end, the amount of effort invested in improving the quality and usefulness of ratings is unquestionable. It is in everyone’s interest to ensure that ESG ratings are transparent, robust, and trusted. We look forward to sharing this report to stimulate new discussions around how we can work together to shape a sustainable investment environment that meets the needs of companies, investors, and raters” (ESG News, 2023)
Based on the report findings, specific recommendations are being offered for both ESG raters, investors, and corporates.
The main recommendation for ESG raters is to reduce the gap between what ratings overpromise and underdeliver and ensure increased transparency. This can be done by providing access to the full methodology behind ESG ratings, and improving responsiveness to corporate complaints and questions, streamlining the questionnaires and process of commenting, improving the quality of ratings by reporting not only on sustainability data but also comprising reliable investment-grade information.
Investors, on the other hand, need to concentrate on ensuring ratings are accurate and useful. To achieve this goal, it is pivotal to cross-check information sources and ensure that ratings accurately reflect sustainability performance and encourage providing recommendations on improvements in methodology and analysis.
Recommendations for corporates circulate around improving their understanding of the right way to strengthen their rating performance. To make this happen, ESG ratings should be prioritized based on the usage frequency, use ratings towards enabling identifying opportunities for improvement and communicating findings to the company, as well as an insight towards the internal risk assessment process. Finally, conduct ESG ratings reviews and peer analyses to improve rating performance.
While it is true to say that a lot of effort and work needs to be put into improving both rating methodology and understanding the importance of it (reaching far further than another control system in place), the scope, complexity, and speed behind introducing and integrating ESG are not making things any easier. This being said, it will take a while for the ratings to meet their main goal of maintaining business and investor trust, however, influencing broader conversations about corporate sustainability cannot happen from one day to another.
* Rate the Raters was first launched in 2010. Through a series of reports, the program was designed to better understand the ESG ratings landscape and provide perspectives to help companies, investors, and other stakeholders make sense of and derive more value from ESG ratings.
The 2022 survey was developed using the survey platform Alchemer and was distributed to over 1,400 corporate sustainability professionals and 450 investment professionals across 20 industries, six asset classes, and 29 countries. Survey links were distributed by conduits including email lists, social media, professional networks, and two 2022 Rate the Raters blog publications. Data was collected between 21 September and 11 November 2022, resulting in responses from 104 corporate and 33 investor respondents (ERM.com, 2023).
References:
ERM.com (2023) “New ERM report ranks ESG ratings agencies and urges action to maintain business and investor trust” Available at: https://www.erm.com/news/new-erm-report-ranks-esg-ratings-agencies-and-urges-action-to-maintain-business-and-investor-trust/ (Accessed: 14 April 2023)
ESG News (2023) “ERM Report Ranks ESG Ratings Agencies and Urges Action to Maintain Business and Investor Trust” Available on: https://esgnews.com/erm-report-ranks-esg-ratings-agencies-and-urges-action-to-maintain-business-and-investor-trust/ (Accessed: 14 April 2023)
Rate the Raters (2023) “ESG ratings at a crossroads” Available at: https://www.sustainability.com/globalassets/sustainability.com/thinking/pdfs/2023/rate-the-raters-report-april-2023.pdf (Accessed: 14 April 2023)