First of all, the process of generating an ESG rating is not standardized, and there is more than one agency that produces ESG ratings. A number of ESG rating providers compete with each other, and each one uses its own methodology. MSCI, Sustainalytics, S&P Global, and – in Switzerland – Inrate and RepRisk rank among the best-known ESG rating agencies. In the B2B context, Ecovadis, for example, is a key player. If it is only about the “E” in ESG, CDP is an important rating agency, focusing primarily on climate, water, forests, and plastics.
The different approaches employed by the various agencies sometimes make it hard to compare ESG ratings. But regulatory pressure is mounting, and the agencies are constantly working on making their ratings transparent and standardizing them to render them comparable with each other.
Although all rating agencies’ methodologies differ from each other in their details, the work steps they follow normally are similar. The specific ones listed below are critical:
- Evaluation of Rating Criteria
An agency must first define what factors are essential to calculating an ESG rating, asking the following questions: Which ESG factors might affect a company’s success? And which ESG factors harbor potential legal, reputational, and regulatory risks? Those factors may vary depending on the size of a given company and the sector and locations in which it operates.
- Data Collection
Once the criteria have been defined, a rating agency then needs to gather corresponding data. There are generally two ways to collect the data. A rating agency either gleans the data from information in the public domain, such as from companies’ annual reports and sustainability disclosures and from media reports, or the companies to be assessed fill out ESG questionnaires and submit them to the rating agency.
- Scoring System
Once all of the necessary data have been collected, then comes the next challenge: agencies must turn the data into a rating. That requires a system for scoring and weighting each data point. Here, too, each rating agency applies its own methodology. The weighting of each aspect ultimately is very customized and again differs from industry to industry.
Interestingly, most ratings are based on a comparison with other companies within the same sector. So, a good ESG rating doesn’t necessarily mean that a company is operating its business very sustainably, just simply better than the comparator group defined by the rating agency.