Simon Boyle, Professor Robert Lee and Tom Venables of Landmark Information Group, and James Bee of Latham & Watkins LLP, consider how a company’s ESG performance can be evaluated by using global standards and ESG ratings and reporting providers.
Ten or so years ago when investors were selecting investments, their focus was almost entirely on the financial status and prospects of the company. The methodology for this was well understood and ultimately binary- what would be the financial return of their investment over a given time period?
Increasing societal concerns around environmental topics such as climate change and social issues such as workplace diversity and inclusion have shifted corporate responsibility radically up the business agenda. As a result, investors now focus intensely on a further substantial issue- the sustainability or ESG performance of the company. Simply put is this company a force for good in the world making a longer-term contribution to the global economy and to the health of the planet? While investors such as pension funds may have ethical reasons for making investments in a ‘good’ company, there is also growing evidence that companies with high ESG status perform financially better over the longer term than those of a lower status. There are a number of reasons for this but one is simply that companies performing well on ESG are professionally run organisations with loyal and motivated staff, which makes for a more resilient company. Good ESG practices are built around the measurement, transparency and third party validation of data and performance metrics.
One difficulty, however, is that the ESG label encompasses a vast and varied range of criteria. How can it all be objectively measured so that the investor can look at meaningful, objective and comparable ESG scores from which informed decisions can be made? This is problematic when investors may have different estimations of what they deem ‘material’ or relevant for their specific needs.
Arguably, it is never going to be possible to bring total objectivity to ESG assessment. Right from the start subjective judgements are usually taken. For example, there will be categories of investments that the ESG minded investor may exclude entirely. Gambling, tobacco and defence are three of the most common. The reasons for this are morally based, but by no means straightforward. For example in the light of events in Ukraine, investing in a British defence company providing essential defensive weapons to Ukraine might suddenly be thought to be acceptable.
This process of exclusion has a long history and is relatively simple to operate in comparison to choices about active investment, which may require a list of those criteria to be evaluated under each of the three headings of E, S and G. Unsurprisingly there is no definitive list to draw upon. One most commonly used is by PRI (Principles for Responsible Investment) which gives a list of over 50 subjects from biodiversity (E), employee relations (S) to tax strategy (G). Each of these factors then needs to be evaluated. Given the breadth represented by ESG, together with the lack of standardisation of criteria, measures and available data, it is easy to see why there can be a divergence in scoring by the various ESG providers. This does not make such an exercise worthless but the investor needs to be aware that ESG evaluation is not an exact science but more of an evolving discipline, from which comparisons and approximations can be made.
A brief history of ESG standards
It is widely accepted that ESG standards are crucial to provide objectivity and extract meaningful and comparative data. Without such standards companies could cherry pick the data that it most suited them to disclose and greenwashing would be rife. By the application of clear standards sustainability can be defined, measured and reported. However, as often happens with such governance initiatives, a number of overlapping global ESG standards have evolved. Though initially competing, these are now slowly converging. Some are considered to be more general in their application; others are more sector specific applying to (say) real estate or infrastructure. In the following section, the leading initiatives are reviewed.
GRI
The Global Reporting Initiative (GRI) was established in 1997 with the support of the UN. In 2000 it published its Sustainability Reporting Guidelines and in October 2016 the GRI Standards were launched. GRI Standards divide into three main parts: Universal Standards, Sector Standards and Topic Standards. The Universal Standards set the scene and include such matters as how to disclose information and what constitutes materiality
The Sector Standards are detailed requirements on disclosure for specific industry sectors. 40 such standards are planned but to date only two have been produced. By following the standards the corporate entity will disclose their most significant impacts on sustainable development, thus allowing investors and other stakeholders to make informed decisions. The two standards that have been published are GRI 11: Oil and Gas 2021 and GRI 12: Coal 2022. The next standard to be produced will be GRI 13: Mining. The Sector Standards set out the likely material topics for that sector. Not surprisingly for the Oil and Gas Standard, the list is long – 22 categories in all starting with greenhouse gas emissions. That then refers across to the Topic Standards GRI 302: Energy and GRI 305: Emissions. In this way there is full integration between the GRI standards.
The role of Topic Standards may be clear from this description; they set out clear instructions for making the relevant disclosures. There are 32 in total and these run from Economic Performance (GRI 201) to Customer Privacy (GRI I48). They are beginning to have real traction, so that, for example, GRI 305 Emissions starts off by requiring the disclosure of Direct (Scope 1) GHG emissions. The GRI was the European Union’s preferred partner to work with on EU corporate sustainability reporting standards and is more widely used than other standards by businesses and investors within the EU.
SASB Standards
The Sustainability Accounting Standards Board (SASB) was set up in 2011 and is based on industry specific standards. Its main function is to encourage companies to report on specific sustainability metrics so that investors can make informed decisions when assessing how well a company is performing on against sustainability criteria.
There are currently 11 sector categories, which each have a number of industries within them, giving a total of 77 industries. For example the sector headed consumer goods has within it the industry of appliance manufacturing. Each of the 77 industries then has its own industry standard, developed over a number of years and through consultation with investors and industry. These typically run to between 10-15 pages and set out precise reporting requirements that are linked to sustainability. For example appliance manufacturing has metrics relating to product safety and to the environmental impacts of the product during its lifecycle. The first metric is to disclose the annual number of products recalls and then the total number of units recalled for each recall. The standard does not give any numbers on what is an optimum level of recalls, bearing in mind that a recall could be seen as good prudent practice or evidence of shoddy production. It is all about recording the data and then making it available to investors and other interested parties to employ as they wish.
SASB then has a Sustainable Industry Classification System which can be used to determine the main industry profile for a given company. What is unique about the SASB classification is that it groups industries together according to their sustainability profile. The health care thematic sector, for example will cover a range of activity including biomedical and pharmaceutical product development, medical equipment manufacture, but also services delivery such as health care of managed care provision and retail and delivery activity.
SASB does not make value judgements on what or is not a sustainable industry per se. So, for example, there is an industry standard on coal operations. But the standard then sets out precise requirements for reporting- for example
The entity shall disclose its gross global Scope 1 greenhouse gas (GHG) emissions to the atmosphere of the seven GHGs covered under the Kyoto Protocol—carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O),hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulfur hexafluoride (SF6), and nitrogen trifluoride (NF3)
Value Reporting Foundation
The GRI standards and SASB standards covered above could be seen as complimentary. GRI comprises a more global standard looking at how ESG issues could impact on the environment and society. SASB however, primarily reviews ESG issues through the lens of financial materiality, for instance how a product recall could have a financial impact on the performance of a business. However, having two sets of standards that were doing very similar things created complexity rather than clarity.
The International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB) officially implemented their merger to form the Value Reporting Foundation (VRF) in mid-2021. Since 2020 there has been collaboration between SASB (now the VRF) but still no consensus has been reached regarding full consolidation.
In late 2021, the formation of yet another organisation was announced, the International Sustainability Standards Board (ISSB) combining the VRF (which houses the Integrated Reporting Framework and the SASB Standards) and the Climate Disclosure Standards Board (CDSB-an initiative of CDP, a not for profit company which began life as the Carbon Disclosure Project). The aim of this conglomeration is to develop global baseline standard for sustainability disclosures by consolidation and building on existing initiatives.
GRESB
Formerly the Global Real Estate Sustainability Benchmark but now known by its acronym, GRESB was founded in the Netherlands in 2009 by pension managers. The idea was to provide a means by which the ESG performance of property portfolios could be assessed by investors. GRESB is now one of the principal ESG disclosure frameworks, which has become the framework of choice for asset managers and investors and has been used as a competitive lever for organisations in this sector.
GRESB uses responses to annual ESG surveys to inform real estate investors of the ESG performance of commercial real estate portfolios globally. GRESB therefore developed a set of standards and assessments, for real estate owners, managers and developers. These are used by property managers to measure the current environmental footprint of their portfolio (by measuring) but also, to prepare for the effects of climate change.
In 2021 1,520 property companies, REITs, funds and developers across the world took part in the GRESB Real Estate Assessment. Each entry is scored and in 2021 the average Standing Investments Benchmark score was 73 and the average Development Benchmark score was 79.
The GRESB annual surveys show continued increases in performance and by giving a benchmark provide an incentive for entities to improve and prove themselves more attractive for investment. GRESB has aligned its assessments with the most widely used of the reporting frameworks s GRI, PRI, SASB, TCFD, Paris Agreement, CDP, SDGs.
ESG Data
Broadly, you can break down ESG data into four different categories depending on its application and availability. Firstly there is data collected and disclosed by individual companies on their own operations some of which will be publicly available. Secondly there is data on companies that is collected by third parties including NGOs and regulators. Thirdly there is data on industry or sector level risk topics (but not on the individual companies) such as those developed by standards organisations like the SASB Standards. And lastly there is geographic data that talks to the issues that are far more specific depending on the region of the globe you are looking at.
There are many global databases which when used together can provide an overall assessment of a given entity operating in one or more global locations. The World Bank has a number of databases including on air quality and energy management. Other useful sources are the Children’s Rights and Business Atlas, a joint initiative by the Global Child Forum and UNICEF which has data on child labour. The Fragile States Index (FSI) by the Fund for Peace combines various datasets in assessing fragility, whilst the World Resources Institute has global data on water stress and water scarcity. Whilst these databases do not provide company specific information they can be used to provide an overall context where an entity is operating. So for example many countries in the Middle East and Africa have, not surprisingly, the highest number of water stressed countries. Unfortunately, the severity of water stress will increase over the years as a result of climate change. At the moment there is no universal ESG data base (and there may never be one) and therefore to get an overall ESG rating or score (unless using GRESB) it is necessary to go to a ESG ratings provider.
ESG Ratings and Reporting Providers
These providers tend to fall into three main camps. First are those whose main function is to provide an overall ESG score for companies. They tend to focus on publicly listed companies and allow an investor to consider the ESG performance of a company when looking to make an investment. Information and data is generally captured from financial disclosures. Table 1 offers examples of the main ESG rating providers.
The second are those providers who primarily provide a due diligence assessment where more detail is needed on key issues identified for those looking to buy a target company. These providers tend to be used primarily for private companies where there is often less available information but they can provide initial intelligence on risks and opportunities. Table 2 offers examples of these providers.
The third, are those that track performance and allow metric collection and KPIs to be set. These tend to be useful for fund managers or investors with a portfolio of businesses. Tracking performance from acquisition through to exit can provide demonstrated value and improvement against ESG metrics, which in turn may be viewed favourably when combined with financial performance.
Table 1: ESG rating providers
| Name | Product |
| MSCI | MSCI collectspublicly available data from many sources and from that provides an overall ESG rating for a company. It will normally contact the company itself for data. MSCI considers what a significant risk would be for a particular company. It gives the example of a mining company and a consumer finance company. Water is far more critical to the mining company whereas cybersecurity is likely to be critical to the finance company. At the end of their assessment MSCI give an overall ESG score from AAA to CCC. |
| S&P Global ESG Score | A company wishing to receive an ESG assessment can contact S&P who offer a Global ESG Rating. The company then completes the Corporate Sustainability Assessment which looks at the company’s ability to manage ESG risks and to maximise opportunities. S&P will then contact a director of the company to collect further information. S&P will also draw upon its own ESG Risk Atlas. From these various sources a detailed ESG assessment report and a global ESG score (from 1-100) is provided. |
| Sustainalytics | Sustainalytics started as an independent ratings provider, however, since 2020, it is now owned by Morningstar. Aside from providing comprehensive ESG ratings for businesses, it also offers carbon-specific, governance-specific, and country ratings. It covers 20 ESG issues, capped at 10 issues per company. Sustainalytics makes many of its ratings available via a basic search on its website. It utilises automated analysis of ESG reports and reportedly covers over 12000 companies. |
| EcoVadis | EcoVadis is a Paris based enterprise solutions business founded in 2007. The business sustainability ratings provider evaluates how well a company has integrated the principles of CSR and sustainability into its processes and management systems and primarily focuses on the sustainable procurement practices of a company’s supply chain and its sourcing framework. It has created a network of over 90,000 rated companies. The methodology is built on standards including the GRI and the United Nations Global Compact and their Sustainability Scorecard illustrates performance across four key themes. |
Table 2 Due diligence assessment providers
| Name | Product | Key features |
| Rep Risk | RepRisk is based in Zurich and provides ESG due diligence on global companies. It bases its assessment on a number of standards including SASB. RepRisk uses AI advanced machine learning and its consultants to identify material ESG risks on companies, real assets, and countries. RepRisk deliberately does not use reports and information produced by the target company and instead focuses on a range of information sources including social media and government bodies to build a risk profile of a company. RepRisk provide solutions including a risk platform, datasets and metrics, data feed as well as reporting and monitoring in 23 global languages. | AI advanced machine learningFocus on public sources and stakeholders excluding company self-disclosuresResearch scope of 28 ESG issuesMapped to UNGC Principles, SASB and the SDGs |
| Landmark Information Group – Risk Horizon | Risk Horizon is run by a UK company, Landmark Information Group. The reports are primarily aimed at ESG due diligence for private companies where public data is limited. Reports are prepared by a Landmark ESG specialist using the Risk Horizon software platform supplemented by online searches following a prescribed methodology which cover reputational and operational issues. The platform is based on the SASB materiality map which identifies key risks against each of the 77 industry types along with data by the leading sustainability consultancy Anthesis. These surfaced risks are then checked against over 45 global data bases from which key issues are identified and scored. For example a mining company will have a number of ESG risks surfaced by SASB, one of which is tailings storage management. The platform will then interrogate the relevant global data set, in this case data from the Global Tailings Portal. From that a score is produced depending on the country. For example a mining company with operations in Brazil would be considered a high risk for this topic due to the country ranking across relevant parameters including consequence of failure and number of facilities. The platform also produces two levels of due-diligence questions which the consultant will answer based upon internet searches, analysis of external databases and information that may be available directly from the target company. An overall inherent risk profile rating will be given and, with the more detailed assessment, an ESG maturity score is produced benchmarking company performance. | Suitable for both public and private companies Company specific consultant analysis and researchMethodology covers both company disclosures and external publicly available informationMapped to SASB standards and materiality map supplemented by Anthesis data covering 45+ ESG risk topics |
| ERM – ESG Fusion | ERM launched their on-demand report platform ESG Fusion in late 2021. This uses AI to provide a comprehensive assessment of a company’s ESG risks and opportunities. They have 15 ESG topics, 60 material risk and 90 management maturity indicators all of which have been created by ERM. It is based on an ESG Sector Topic Map which is unique to ERM and based on their own extensive experience. Information is primarily obtained from the internet and uses ERM’s SmartFetch technology consisting of automated web crawlers which is supplemented by a number of data providers and curated by analysts. The platform also allows portfolio monitoring as well as ESG benchmarking. | AI and automated web crawlersFocus on private marketsTwo ESG risk scoring dimensions Evaluates 15 factors from climate change to supply chain risksPowered by ERM’s proprietary technology and analyst-driven methodology |
Note on climate change standards
This article has not covered standards in relation to climate change only, though climate risks are included in many of the ESG evaluations discussed. Of relevance, here is the Climate Disclosure Standards Board (CDSB), which was instrumental in forming the Task Force on Climate-related Financial Disclosures (TCFD) standards. The CDSB has now been consolidated into the IFRS Foundation to support the work of the newly established (November 2021) International Sustainability Standards Board (ISSB). The intention is for the ISSB to deliver a comprehensive global baseline of sustainability-related disclosure standards. This will provide investors with further information about the sustainability risks and opportunities of companies.
There is now an appreciation that the environment cannot be treated as an externality and that all businesses need to operate within planetary constraints. There is also a much greater knowledge of the responsibilities that organisations owe to their staff, stakeholders and to the wider community to act with fairness and integrity. The recent P&O debacle shows that a Board that ignores these wider social issues does so at its peril. Investors are therefore alive to ESG issues and take into account the ESG credentials of a business when making investment decisions. To provide objectivity on ESG assessment a number of global standards have been set up. However there is a lack of standardisation that makes this assessment more complex than it needs to be. While it is to be hoped that this is resolved in the near future, in the meantime there are a number of valuable tools available to assist with ESG assessments.
Reproduced from Practical Law with the permission of the publishers. For further information visit www.practicallaw.com