What Is ESG Ratings & How It Reflect Climate-Change Risks and Opportunities?

Environmental Social and Governance (ESG) is a new-age metric that takes a holistic approach to evaluate business activities. It keeps businesses on the path of sustainability by factoring in various social and environmental elements that affect society collectively. ESG ratings are a numerical estimate of a company’s performance collectively on the ecological, social and governance accounts. ESG rating agencies evaluate a company’s ESG policies and then give their scores based on its planning and execution to achieve sustainability in business.

Key ESG Considerations

We now know that an ESG rating takes environmental, social and governance factors into account to deliver a score. This process is quite complex and involves deep ESG research to derive conclusions. One of the most popular ESG ratings is known as the MSCI ESG score. Here’s how companies are evaluated based on each key factor.

Environmental Score

The MSCI score takes the most critical environmental issues into account. This includes problems that are categorised under climate change, waste and pollution, natural capital and ecological opportunities. Each of these four categories is further divided into subcategories. The climate change category includes factors such as carbon emissions, the carbon footprint of products, climate change vulnerability, financing environmental impact. The natural capital category entails biodiversity and land use, sourcing of water and raw material. Environmental opportunities include progressive technologies, such as renewable energy, clean technology, and green buildings.

  • Social score

ESG agencies classify social score issues under four categories: product liability, human capital, social opportunities, and stakeholder opposition. Human capital issues are further divided into worker training, labour management, health and safety practices, and supply chain labour standards. Social opportunities entail communication, healthcare & finance accessibility. It also includes options in health and nutrition. The stakeholder opposition segment includes community relations and controversial sourcing.

  • Governance score

Governance issues are summarised under two groups, i.e., corporate governance and corporate behaviour. Corporate governance issues include diversity in the board’s composition, executive compensation, ownership, and accounting practices. Corporate behaviour entails business ethics and tax transparency.

Benefits of ESG rating

ESG ratings are given after conducting thorough ESG research related to a business. The rating evaluates a company’s exposure to long-term social, environmental, and governance challenges from a broader perspective. This risk can have negative financial consequences for the business in the long run. Let’s take a quick look at some essential benefits of ESG ratings.

1. Improves brand image

Socially conscious consumers are more likely to purchase from a business that is ethical and take social or environmental factors into account. A positive ESG rating can help companies improve their brand image and boost sales. A higher rating will attest that the company is following the highest social, environmental and governance standards.

2. Attract potential investors

Another significant benefit of a good ESG rating is that it helps to attract potential investors and boosts confidence among existing ones. Many reputed financial institutions and portfolio managers have started investing the fund’s capital in a business that complies with ESG policies. A higher ESG rating score will surely help businesses to attract more investors.

Must Read: Covenant Analysis: What Is It, Why Is It There And How Does It Work?

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