There’s no doubt that capital markets aren’t pricing the sustainability costs around businesses adequately. Important factors like the impact of an unhappy workforce, security of company data and vulnerability to climate change aren’t accounted for. While these factors aren’t usually part of traditional financial analysis, they are known to have a growing financial impact on companies.
Hence, companies looking to account for these unconventional costs to position their portfolios to have a greater chance of long-term success, business owners have started adopting ESG criteria to assess various non-financial factors. ESG, which is an abbreviation for Environmental, Social, and Governance, takes into account these three factors in order to measure the ethical impact and sustainability of a company.
Basically, the ESG criteria take into account the ‘unmeasured’ and ‘unrepresented’ factors related to the environmental, social and governance niches. As it takes into account the factors that aren’t considered in traditional financial analysis, it captures the sustainability of a company in the most precise manner.
Due to this, ESG Consulting have gained immense popularity and have outperformed traditional portfolios by a large margin. After analyzing over 2000 studies, it has been confirmed the tangibility of the responsible and economic benefits of the ESG portfolio. Moreover, in Europe, there was an 11% increase between 2016 and 2018 with regards to the total number of assets that were committed to executing strategies that are sustainable and responsible.
How Are ESG Ratings Calculated
With more companies showing interest in the ESG criteria, it has become imperative to objectively assess the ESG performance and ratings of a company. The initiative to carry this out is led by various ESG Rating Agencies, including Sustainalytics, MSCI, and FTSE ESG. These companies are responsible for assessing companies globally and determine their ESG performance, which is then made public and freely available for their clients.
These ESG ratings are also used to determine the risks a business faces, hence, they need to be as comprehensive as possible. To accomplish this, the companies are evaluated based on the information available on various media sources and annual reports. The scores are then given to each material, i.e. ‘E,’ ‘S’ and ‘G,’ which then culminated for an overall score.
Why Your ESG Score Matters
A study conducted by Oxford University and Arabesque revealed that a majority, i.e. 88% of companies that focused on sustainability and operational performance say an improvement in their cash flows.
This is because companies that score well in the ESG criteria are capable of identifying future risks and embracing opportunities for growth. This indicates that they are more prone to strategic thinking and focus on adding long-term value instead of short-term gains.
Companies should continuously strive to attain a high ESG score as it directly impacts the perception of the company. For example, if your company gets a low ESG ranking, it can be considered as an unsustainable asset by investors and the stock will be excluded from their investment portfolio. If multiple investors follow this mindset, it will eventually lead to a negative impact or a drop in your stock price.
Moreover, ESG ratings are also extremely valuable when it comes to creating internal benchmarks that are useful in decision making and improving sustainable performance.
Hence, you should consider opting for a review from an external expert on your firm’s ESG performance. This will give you a better understanding of the position of your company as compared to your peers and competitors.