Book Premiere: The Guide to ESG Rating Essentials
Navigating sustainability issues and measuring ESG progress successfully have become a complex, often heated matter. Debates will come and go, the demand for expertise in this field will remain. Hence, it’s a perfect time for a comprehensive book that provides a deep dive into how innovative ESG ratings should work and covers the secrets of the billion-dollar ESG data industry.
Since the meanwhile very well-known acronym “ESG” (environmental, social, and governance) was coined in 2005, and until recently, its fortunes were steadily growing. According to Google Trends there has been an almost fivefold growth in internet searches for the hit name ESG since 2019. Across all sectors, geographies, and company sizes, organizations have been allocating more resources toward improving its ESG activities and mostly launched environmental initiatives.
However, there are also increasingly political motivated attacks on ESG-related standards and environmental sensitive investing. As recent example, Governor Ron DeSantis stated that he will “reasserting the authority of republican governance over corporate dominance” and will “prioritizing the financial security of the people of Florida over whimsical notions of a utopian tomorrow.”
Despite these heated, unbalanced debates, more than 90% of S&P 500 companies now publish ESG reports in some form, as do approximately 70% of the much broader Russell 1000 companies. In several jurisdictions, reporting ESG elements is either mandatory or under active consideration. In the United States, the market regulator SEC is considering new rules that would require more detailed disclosure of climate-related risks and greenhouse-gas (GHG) emissions.
This is good news regarding a broader and hopefully better data universe—on both sides of the Atlantic Ocean. Such data are quintessential to score and rate a company’s behavior in the aspects of environmental, social, and governance. The rising profile of ESG has also been plainly evident in investments, even while the rate of new investments has recently been falling.
Inflows into sustainable funds rose from $5 billion in 2018 to more than $50 billion in 2020—and then to nearly $70 billion in 2021; these funds gained $87 billion of net new money in the first quarter of 2022, followed by $33 billion in the second quarter, according to Morningstar. In other words, the money flows are more and more directed towards companies’ which take its ESG homework seriously and simultaneously demonstrate a good performance on the corporate E, S, G segments.
This is where ESG ratings come into play. In its simplest form, an ESG rating is a formal, independent opinion or grade used to quantify a company’s ability to fulfill certain environmental, social and governance goals. However, based on feedback from financial market participants (sell side) and investors (buy side), conventional ESG ratings have some shortcomings. These ratings are only partially meaningful, sometimes confusing, very costly for subscribers and often non-transparent. In addition to these criticisms, misinterpreted or inexplicable ESG ratings are also causing legal and regulatory risks.
It’s high time to cover this topic in a comprehensive way and write about ways to reshape conventional approaches on ESG ratings. I had the pleasure to capture many aspects of measuring the green credentials of a company and describe the new ESG rating mechanism called “Pure Play Dynamics”. This approach is progressive and transparent the same time. As always, slight refinements are part of the evolution.
This publication is dedicated to all sophisticated investors interested in ESG scorings who are open-minded enough to take in and digest some critical thoughts on the current state of the industry before forming their own opinions on how best to optimize and enhance their ESG risk analytics: portfolio managers, registered investment advisors, high-net worth individuals, family offices, endowments, and other institutional investors. No matter whether you are a well-educated investment professional or an ESG novice, you will probably find something to interest you in this book. Any constructive feedback is welcome—enjoy reading!
PS: Etwas Geduld, bitte. The German-speaking edition will follow in the next weeks.
About the author
Martin Raab is a long-time investment professional, book author, and member of the Board of Directors of Global Green Xchange. He manages the ESG Ratings & ESG Data division. As one of the authors of the newsletter "Green Money" and of ESG Insights, he regularly analyzes and reports on various topics related to sustainability and capital markets.