June 12, 2019

ESG: Ratings Are Up, But So Are Controversies

Recently, ISS ESG (the “responsible investment” arm of ISS) announced its annual ratings of ESG performance for companies across the globe. At first glance, things look good:

This year’s report finds the share of companies covered by ISS’ Corporate Rating and assessed as “good” or “excellent” (both assessments lead to Prime status) now stands at 20.4 percent, up from just over 17 percent in the previous year. This year’s report also shows that the group rated with medium or excellent performance (on a four-category scale of poor, medium, good or excellent) now includes more than 67.5 percent of covered companies in developed markets. This represents an all-time high over the 11-year history of the report. Similar patterns can be observed among companies in emerging markets, the report finds, albeit at a considerably lower level.

But the jury’s still out on whether companies are following through on the sustainability strategies that they’re touting. We’ve blogged that CSR statements might serve as the basis for plaintiffs’ claims – and the ISS ESG analysis confirms that these types of disputes are on the rise. Here’s an excerpt:

Meanwhile, Norm-Based Research, which identifies significant allegations against companies linked to the breach of established standards for responsible business conduct, saw a more than 40 percent rise in the number of reported controversies across all ESG topics. This exemplifies a growing misalignment of corporate practices with stakeholder expectations that are grounded in UN Global Compact and the OECD Guidelines for Multinational Enterprises.

At the close of 2018, failures to respect human rights and labour rights together accounted for the majority (56 percent) of significant controversies assessed under ISS ESG’s Norm-Based Research. Industries that are most exposed to controversies in the environmental area are Materials, Energy, and Utilities. On social matters, Materials is also leading, similarly followed by Energy and Capital Goods. The governance area sees most controversies within Banks, Capital Goods, and Pharmaceuticals & Biotechnology.

ESG Ratings: Making Sure They’re Accurate

This 19-page DFin paper points out that it’s increasingly important to understand your ESG ratings and correct any errors, because investors are using them to evaluate non-financial performance and compare your company to other investment alternatives (e.g. this blog says that the universe of “sustainable funds” grew by 50% last year – also see this WSJ article). In addition to outlining the issues that factor into ratings, DFin gives seven steps to ensure accurate scoring:

1. Learn about existing ESG ratings frameworks
2. Know your ESG scores
3. Compare yourself to your peers
4. Understand how the various ratings standards compare to one another
5. Attend to the raw data your company provides – the data comes from SEC filings, your website, blogs, social media, etc.
6. Supply information proactively
7. Sharpen your communications

ESG: Advantages for Small & Mid-Cap Companies

We’ve blogged (sometimes more than we’d like) about the growing interest in ESG topics – among institutional as well as retail shareholders, and even credit rating agencies. While most large cap companies are now publishing sustainability reports and incorporating ESG metrics into business decisions, many smaller companies are just beginning that journey.

This blog from Next Level Investor Relations explains how even thinly-staffed small & mid-cap companies can identify strategic & disclosure-based ESG improvements that can improve their business, make important customers happy, and enhance their access capital. Here’s an excerpt (also see this blog from the Governance & Accountability Institute addressing ROI for sustainability efforts):

As highlighted in recent Gartner supply chain research, “ESG has emerged as a source of growth & innovation strategy for supply chains, spurring better performance & mitigating supply chain risks.” So why develop the widget (or ESG disclosure) that nobody wants? What are your customers (and competitors) focusing on in their ESG/Sustainability disclosure and supplier questionnaires?

AlphaSense search on ‘ESG Sustainability AND Profitability’ for the latest 12 months found 56 small and mid-cap companies across 10 sectors, with related disclosure including supply chain policies, expectations and supplier audit practices across the cap range, from $266mm market cap Natural Grocers by Vitamin Cottage [$NGVC] to Tetra Tech [$TTEK] and Goodyear [$GT], market cap $3.3bn and $4.2bn, respectively.

Liz Dunshee