ESG Ratings and Rankings: Which One is Right for You?

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Sustainalytics vs. MSCI vs. S&P Global ESG Indices

As ESG becomes an increasingly important issue, more companies face growing investor and stakeholder expectations. Additionally, increasing regulatory compliance requirements must be accounted for. Investors are progressively integrating ESG considerations into their decision-making process. A growing number of these managed funds require specific mandates on strong ESG performance before committing to investments. One way companies demonstrate their commitment to ESG and sustainability-related issues is through obtaining ESG rating assurance from organizations such as MSCI, Sustainalytics, and the S&P DJI.

Why do ESG ratings matter?

Utilizing ESG Rating and Ranking services helps companies meet regulatory requirements and stakeholder expectations as well as gives companies an increased chance of access to capital, with a competitive advantage in the ESG investing space. Internally, ESG Rating and Ranking Scoring systems can be used to improve long-term sustainability planning, both tactically and strategically, and help those organizations identify and address ESG-related risks. ESG Rating services provide companies with the ability to assess, benchmark, and communicate ESG performance effectively. Implementation of these tools improves reputation, mitigates risks, and positively affects access to new opportunities.

Which ESG rating is right for you? 

While only eligible S&P DJI companies are included in the ESG indices, Sustainalytics and MSCI are voluntary rating systems that companies can partner with to receive evaluations and scores. Sustainalytics uses an absolute approach to highlighting risk, while MSCI uses a sector-relative scoring approach. Sustainalytics’ absolute approach makes comparisons of companies across different sectors and geographies simple due to the consistency of the standards. MSCI’s sector-relative scoring approach is more of a “best-in-class” system comparing companies in the same industries with one another. Some companies obtain ESG ratings from multiple rating systems to provide investors with a more comprehensive picture. 

In this article, we’ll explore and compare these three ESG rating assurance organizations, including their methodologies and rating processes.

Sustainalytics ESG Risk Ratings

Overview

Sustainalytics ESG Risk Ratings measure the degree to which a company’s economic value is at risk to ESG-related factors and how well these risks are managed. Sustainalytics uses a proprietary industry classification system to categorize and then assess companies across 138 subindustries for risk exposure levels and associated risk management strategies. Companies are grouped into one of five risk categories: negligible, low, medium, high, and severe based on the risk assessment findings. Issues are considered material within the ESG risk ratings if their inclusion in financial reporting would be likely to influence investor decision-making processes. Because some issues are considered material from an ESG perspective regardless of their financial materiality, these issues may still be assessed and included in the risk rating analysis.

Methodology

Up to 10 Material ESG Issues (from a list of 20 potential topics) are selected by the Sustainalytics research team for each sub-industry analysis. Individual companies may have metrics added or removed to their analysis based on relevancy to the organization. All companies are subject to risk assessment on corporate governance material issues. Examples of material ESG issues include Human Rights; Emissions, Effluents, and Waste; Land use and Biodiversity; Product Governance, and other relevant ESG issues.

Through their managed risk score proprietary model, Sustainalytics ranks companies individually. Identified risks are determined to be either manageable or unmanageable, scoring with weighted proportionality at the sub-industry level. Manageable risk consists of exposure that can be managed through policies and programs. Unmanageable risks are unmitigable and remain a risk to the company regardless of management practices. An example of this is the unmitigable health risks posed by a tobacco company’s products. Companies also face the possibility of being assessed on idiosyncratic, or unsystematic risks that arise from event-driven ESG-related controversies such as environmental contamination events or failure to disclose carcinogenic additives to products.

A company’s final ESG Risk Rating score is calculated as the sum of unmanaged risk for their Material ESG Issues. Unmanaged risks of Material ESG Issues are calculated as risk exposure minus managed risk. For each assigned Material ESG Issue, exposure is scored on a 0-20 range with 20 representing the highest level of exposure. Each Material ESG Issue score represents a portion of the overall risk exposure score ranging from 0-100. Management scores are calculated as the sum of the weighted scores of each Material ESG Issue. Weights are determined by how much each Material ESG Issue manageable risk score contributes to the overall risk score. Companies receive a final numeric score and are then assigned one of five ESG risk categories: negligible, low, medium, high, and severe.

Rating Process

ESG risk ratings for each participating company are updated annually by the Sustainalytics research team through review of corporate publications, regulatory filings, news and other media, assessment of management indicators, processing issuer feedback on draft ESG reports, and peer review quality assurance processes. News screenings for companies in the Sustainalytics universe are done daily and any ESG-related controversies are processed within 48 hours. Controversy research is conducted and updated on an ongoing basis with identified controversies categorized from 1 (low ESG impact) to 5 (high ESG impact). To analyze management indicators, the Sustainalytics team evaluates the degree to which a company meets relevant best practice standards and assigns the indicator with a raw score value between 0 and 100 based on firmly established companywide internal criteria.  

Companies analyzed through the Sustainalytics ESG Rating system can engage with the research team at any point during the year. Annually, Sustainalytics analysts contact companies to confirm sourced information as part of their ESG Risk Ratings Report updates. Companies are given two weeks to provide feedback and updates which are then integrated into the Risk Rating score. If a significant ESG controversy is identified, analysts reach out to the company to review the facts and provide details on relevant management responses. Companies are given 48 hours to review the accuracy and completeness of the data collected.

Figure 1: Sustainalytics ESG Risk Ratings - The Scoring Structure

Figure 1: The above figure from Sustainalytics details the scoring structure of the ESG Risk Ratings and the associated point values.

MSCI ESG Ratings

Overview

MSCI ESG ratings provide insights into how well companies can manage financially relevant ESG risks and opportunities. The rating system considers exposure to potentially material ESG risks, the quality of management systems and governance structures used to mitigate risks, and the market positioning needed to meet demand for product provisions and services that benefit the environment or society. ESG Ratings are industry-relative, but scores are determined at the individual company level. MSCI utilizes the Global Industry Classification Standards (GICS) which classifies and ranks companies in 163 unique sub-industries. ESG Ratings are given on a seven-band scale ranging from AAA (highest rating) to CCC (lowest rating).

Methodology

Companies are assessed on a selection of two to seven Key Environmental and Social Issues based on exposure to material ESG risks driven by market-specific and industry-specific factors. If MSCI determines a particular issue is not material to a company in a particular industry, the metric is removed. Likewise, if a specific metric applies to one company within an industry but not others, the metric is added to the evaluation process. All companies are assessed on their adherence to the Governance Pillar. The Governance Pillar consists of six “Key Issues” across the Corporate Governance and Corporate Behavior Themes. Evaluation of Governance Pillar requirements is based on the gap between best industry practices and the company’s own governance practices. Management practices are measured relative to their aggregate ESG risks and opportunities such as governance structures, policies and targets, quantitative performance metrics, and relevant controversies.

Rating Process

The MSCI research team uses data points sourced from company financial and sustainability reporting, specialized government and academic research tools, and media searches to calculate exposure and management indicator scores for key environmental and social issues. Exposure score indicators include Business Segments, Geographic Segments, and Co-specific indicators. Management score indicators include Strategy, Programs & Initiatives, Performance, and Controversies. Environmental key issues and social key issues scores (ranging from 0-10) are calculated by totaling the indicator scores from management and exposure scores related to a particular topic. Once scores are determined for each environmental and social key issue, the Environmental and Social Pillar scores are calculated using the weighted average of the key issues scores.

To calculate governance key issue scores, a deduction-based scoring model is used. Management practices currently utilized by the organization related to key governance issues are scored and subtracted from predetermined best management practice scores calculated at the industry-level. Key metrics for determining governance key issues scores include Ownership Characteristics, Board & Committee Composition, Pay Figures, Policies & Practices, Business & Geographic Segments, and Controversies. To calculate the Governance Pillar score, the same deduction-based scoring model is applied.

Once the Environmental, Social, and Governance Pillars scores are calculated, the weighted average of the Pillar scores is calculated to determine the Weighted Average Key Issues Score. This score is compared to industry peer scores and adjusted based on findings. This final score is used to obtain the corresponding ESG Letter Rating (AAA-CCC).

Figure 2: MSCI - Hierarchy of ESG Scores

Figure 2: The above figure details the hierarchy of how ESG Scores are calculated for MSCI. Raw public data is utilized to calculate Key Issue scores, which are aggregated and used to calculate Pillar scores. A weighted average is taken from the Pillar scores to determine the Weighted Average Key Issue Score. The score is then adjusted compared to industry peers and a final ESG letter rating is assigned to the organization.

Figure 3: MSCI ESG Ratings System

Figure 4: MSCI - ESG Letter Grade Rating System Based on Score

MSCI - ESG Ratings by Industry-Adjusted Score

Letter Rating

Leader/Laggard

Final Industry-Adjusted Company Score
AAA Leader 8.571 – 10.0
AA Leader 7.143 – 8.571
A Average 5.714 – 7.143
BBB Average 4.286 – 5.714
BB Average 2.857 – 4.286
B Laggard 1.429 – 2.857
CCC Laggard 0.0 – 1.429

Figure 4: The above figure details the associated ESG letter rating based on the final industry-adjusted company score received by each participating organization. (Data source: MSCI)

S&P Global ESG Index Series

Overview

The S&P DJI ESG Index Series aims to incorporate ESG criteria into market indices for investment purposes. The indices are designed to provide investors with benchmarks to align their investments with their sustainability goals and values. Over 7,300 companies that have opted into S&P’s Corporate Sustainability Assessment (CSA) are evaluated through the 32 ESG indices each year. The ESG scores measure ESG risk exposure and performance factors for corporations across industries with a focus on financial materiality. Investors use the ESG scores to determine portfolio exclusions and conduct best-in-class performance screenings, integrate ESG opportunities and risk mitigation strategies across operations, and target improved ESG performance and increased investment returns.

The S&P DJI ESG Indices use the Global Industry Classification Standards to determine evaluation metrics for the companies assessed in the CSAs and the subsequent ESG Index rating derived from the CSA. Companies that participate in business activities surrounding controversial weapons, small arms, military contracting, coal, thermal coal, oil sands, and tobacco are prohibited from index inclusion.

Methodology

The indices are set up to include all eligible companies in the S&P DJI universe that represent a certain region or market. Data such as sustainability and financial reporting information is collected for each individual company included in the index through the CSA process and ESG scores are calculated for each company. Companies are weighted within a particular index based on their ESG scores. Companies with a higher ESG score typically receive a higher weighting in the index to reflect their strong ESG performance. Indices are constructed using the weighted ESG scores of included companies to ensure that companies with a better ESG performance have a larger influence on the index’s overall performance.

Throughout the year, the indices are rebalanced to account for changes in a company’s ESG scores or changes in the composition of the S&P DJI company universe. When a stock is added or removed from an index, the S&P analyst team adjusts the index divisor to offset the change in the market value of the index and ensure the index levels are not affected disproportionately. Ongoing maintenance is conducted on the indices to ensure accuracy. This includes updating individual company ESG scores, adjusting scoring weights, and incorporating newly eligible companies into the index.

Figure 5: S&P 500 ESG Methodology and the Calculation of S&P DJI ESG Scores

Rating Process

Each year, S&P Global issues invitations to eligible companies to respond directly to the CSA. The CSA questionnaire issued to the company is dependent on the Global Industry Classification Standards (GICS) classification for the company. The industry-specific questionnaire evaluates a range of financially relevant sustainability criteria and potential ongoing negative controversies that the organization could be exposed to. Companies that do not respond to the invitation may still be assessed through the CSA process and receive an ESG score based on publicly available data.

During the CSA process, specific ESG indicators covering several topics are calculated for each eligible company. Each industry has different ESG indicators and associated weighting in the total company-level ESG score calculation. If a particular ESG indicator is irrelevant to companies within a specific industry, the associated weighting is zero. Total scores are normalized based on industry-peer performance to give a measure of how the company performs compared to industry peers.

S&P DJI ESG Scores are updated on an annual basis in segments. The top 3,500 stocks in the S&P universe are updated first in September based on data gathered from that year’s S&P Global CSA for each eligible company. All remaining stocks have their scores assessed between September and March of the following year, with ESG scores reviewed and updated monthly. S&P DJI ESG Scores are made available for use in index selection after the final review and approval of all eligible companies is conducted at the start of May.

Conclusion

Investors, other stakeholders, and evolving regulatory requirements increasingly call for transparent ESG analysis and disclosure. By participating in an ESG Rating or Scoring system, companies can show their dedication to integrating ESG initiatives into their strategy and operations, benchmark their ESG management performance against industry peers and companies across various sectors, and adapt plans to better include risk mitigation strategies based on best practice standards.

While these scoring frameworks can be helpful for companies to evaluate their ESG performance, navigating the complexities of these ESG scoring systems and improving ESG performance based on these assessments can be challenging. At KERAMIDA, our team of ESG experts employs a company-specific tailored approach to help interpret ESG scores, identify areas for improvement, and implement ESG enhancement strategies. Our professionals help companies meet the growing demand for transparency and accountability, unlocking new avenues for growth and expansion with the creation of long-term success and resiliency grounded in sustainability planning and execution. For more information on how KERAMIDA can assist your organization, contact us or call (800) 508-8034 to speak with one of our Sustainability professionals today.

Author

Lauren Besser, MBA
Sustainability Analyst
KERAMIDA Inc.

Contact Lauren at lbesser@keramida.com

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