In the past decade, ESG (environment, social, governance) investing has skyrocketed. More than one-quarter of the total global assets under management (~$20 trillion) is now invested according to ESG criteria. Similarly, $12.4 trillion (1 in 4 dollars) of total US assets under professional management is invested using ESG criteria. By understanding and tracking how a company is managing ESG issues, investors are able to better mitigate risk and achieve long-term returns. The incredible rise of ESG-integrated investment strategies has resulted in an unavoidable call to action for companies to evolve their disclosures to include the management of material ESG issues. It is now the responsibility for companies to answer that call, however, they are largely left in the dark when it comes to how to most effectively communicate ESG.
What is spurring the growth of ESG?
Risk Mitigation- Analyzing how companies are integrating the management of material ESG issues into their overall strategy allows investors to better assess potential future risk. This is pronounced by the fact that more and more investors are determining such things as climate change to be of substantial risk. In a recent study from Edelman, 90% of institutional investors have changed their voting and/or engagement policy to be more attentive to ESG risks.
Higher long-term returns –Harvard Business School Professor George Serafeim reported that an investment strategy that includes companies with superior ESG performance scores and big data analytics delivers positive alpha (higher returns). Additionally, in a recent meta-analysis of ESG data, 88% of sources reflected that companies with robust sustainability practices demonstrate better operational performance.
Consumer demand- Dollar-voting and other conscious-consumer behavior is bleeding into the investment world with individual investors and clients of institutions desiring to invest sustainably. Investing in ESG-driven portfolios or ETFs allow them to do so. BlackRock, one of the largest asset management companies in the world expects ESG ETFs (Exchange-Traded Funds) to rise from $25 billion to $400 billion by 2030.
Why should companies care?
As shareholders increasingly call for greater transparency, by disclosing the management of ESG issues, companies can improve relations, as well as reduce the threat of shareholder activism. Additionally, according to a report by The Boston Consulting Group, companies that outperform in industry-relevant environmental, social, and governance (ESG) areas boast higher valuation multiples and margins, all other factors being equal than those with weaker performance in those areas. Improved performance and greater risk management transparency, will in-turn draw increased investment from asset managers, especially as ESG investing continues to grow. Companies with higher ESG ratings and performance can even unlock lower cost of capital through low-interest loans from banks like ING, who features a “Sustainability Improvement Loan that offers better terms to corporates that are more sustainable.”
Enter rating agencies
In direct parallel to the rise of incorporating ESG criteria into investment strategies, the amount of arbitrators of said criteria has skyrocketed. There are over 100 agencies and counting that offer ESG ratings and analysis. Similar to Moody’s or S&P rating credit bonds, ESG rating agencies are tasked with attributing a score that benchmarks a company’s management of material environmental, social, and governance risks. ESG ratings intend to equip investors, as well as capital providers, with essential information absent from conventional financial and accounting reporting. As a proxy for how well companies are managing material ESG issues in relation to peers, ratings allow for a more holistic and comprehensive study of risk management and long-term performance.
It is important to note that for most rating agencies, the differing methodology and rating criteria used to score companies is their secret sauce and is typically not disclosed. And to further the ambiguity, rating agencies criteria and subsequent scoring differ (sometimes significantly) from each other. In turn, this leaves companies reeling when it comes to deciding what ESG information to communicate, and how to best do so. A common thread, however, among top rating agencies is the wide net that is cast in their analysis of a company’s disclosure and communications. Analysts at rating agencies are viewing and giving weight to a diverse array of a company’s sustainability communications efforts including employee code of conducts, earnings call transcripts, external reviews (like Glassdoor), thought leadership and much more.
Companies are now not only tasked with incorporating a sustainability strategy that outlines the management of material ESG issues, but also effectively communicating its management approach, tactics, and progress of those issues to the investment world. Only then will they get a return on their impact through higher ratings and the aforementioned benefits. However, as opposed to financial reporting, where age-old standards and practices are clearly defined and regulated, there are very few US regulations in place for disclosing ESG. Additionally, the crowd of competing guidelines like GRI, SASB, CDP, and more can also add to the confusion, with no one framework rising to prove most effective when disclosing ESG and improve ratings.
To overcome the lack of regulations, as well as the level of ambiguity and degree of differentiation between the methodologies of rating agencies, companies must adopt a holistic approach when communicating ESG initiatives. This is especially true considering the breadth and diversity of communications rating agencies analyze when grading companies. From refining your sustainability report to strengthening your communication framework to evolving your diversity and inclusion communications there are countless ways in which a company can better communicate the management of its material ESG issues to rating agencies and the investment community. It is imperative that companies clearly and consistently demonstrate the strategy and progress of the management of material ESG issues through a diverse array of messaging and communications.
Interested in learning more about how to best communicate ESG and improve your ratings? We are releasing a whitepaper that explores how to best communicate ESG, including practical guides, in-depth explanations, and best-in-class examples. Subscribe to our newsletter to be the first to receive it. Can’t wait? Contact us to help quickstart the process of improving your ESG ratings and more effectively communicating your sustainability story.