What are ESG scores and ratings?
Key takeaways
ESG ratings and scores are becoming a common investment tool for assessing companies’ environmental, social, and governance performance as ESG data grows and transparency expectations rise.
- ESG scores are typically numerical, while ESG ratings are usually letter-based, with both measuring company performance across environmental, social, and governance factors.
- Companies may receive both overall ESG ratings and more detailed category-level assessments.
- ESG ratings can be based on public quantitative data, analyst qualitative assessments, or a combination of both.
ESG scores and ratings are tools used to assess companies’ performance in respect of environmental, social, and governance factors. ESG scores usually provide a numerical value, such as 1 to 10 or 1 to 100, while ESG ratings are typically letter-based grades; both can include an overall company assessment as well as more granular category-level measures. Their use in the investment industry has grown rapidly over the past decade or so, amid growing scrutiny of corporate ESG performance and sustainability-related claims, with Bloomberg Intelligence projecting that global ESG assets could exceed USD40 trillion by 2030.
This article outlines the purpose of ESG scores and ratings, who uses them, who calculates them (and how), the challenges they present, and how investors and other stakeholders are addressing these issues.
What are ESG scores and ratings designed to do?
Scoring companies on their environmental, social, and governance performance has become an increasingly common investment practice. But what are ESG scores, and how do ESG ratings differ?
ESG scores vs ESG ratings
The terms are often used interchangeably: ESG scores usually provide a numerical value (typically 1 to 10, or 1 to 100) while ESG ratings are typically letter-based grades. Both aim to assess companies’ performance in respect of environmental, social, and governance factors. A company will typically receive an overall ESG rating or score as well as more granular ones for different categories.
These ratings are predicated on the notion that companies with better scores will exhibit better financial performance over time because they face lower ESG risks, and are more adept at managing them, or some combination thereof, as a CFA Institute blogsuggests.
Who uses ESG scores and ratings, and why?
ESG scores and ratings are used by a range of financial institutions and market participants to support investment decisions, risk assessment, and stewardship activities. Common users include:
Institutional investors and asset managers: Use ESG scores and ratings to support asset-allocation decisions, portfolio construction, investment research, and risk assessment. The metrics can help investors align investments with their values or mandates, identify ESG-related risks and opportunities, compare companies, and pursue long-term performance objectives alongside traditional financial analysis.
Banks: Consider ESG scores and ratings as part of their risk assessments when making corporate lending decisions. ESG performance can provide additional insight into a company’s resilience, governance practices, and exposure to environmental or social risks that may affect its ability to meet its financial obligations.
Insurers: Use ESG information to better understand corporate policyholders’ operational management and broader risk profiles, including governance and climate-related risks. These insights may inform underwriting, pricing, and risk-management decisions.
Lenders and debt investors: May incorporate ESG performance into financing decisions and terms. For example, lenders may offer lower interest rates or other favourable terms in return for improved ESG performance, including through sustainability-linked loans. In the bond market, companies may also raise capital through green, social, or sustainability-linked debt.
How are ESG scores and ratings calculated?
ESG rating methodologies can vary widely across providers. Typically, ratings are calculated using a combination of:
- Quantitative data, such as company disclosures and publicly available reports
- Qualitative analysis, where analysts assess governance structures, environmental policies, and social initiatives
The data is typically assigned to various categories and a separate score produced for performance in each of the three categories, and then overall for the company.
Who produces ESG scores and ratings?
The biggest providers tend to be well-established credit rating, index, or analytics companies. The number of services on offer has ballooned in what has so far been an unregulated market, but that is set to change with the introduction of regulatory requirements in markets like the EU and UK. These efforts broadly aim to improve the reliability of ESG data and transparency of how it is produced.
What are the main issues with ESG scores and ratings?
Various concerns have emerged over the practice of ESG scoring, including:
- Over-reliance on ESG ratings as green or sustainability credentials, when they actually tend to focus on how companies manage their internal processes, rather than on the real-world impacts of those companies’ products and services;
- Inconsistency between providers: the weight given to various individual ESG factors can lead to wide variations between the scores and ratings from different ESG data providers, making it hard to compare them directly across individual companies or between sectors;
- Availability of data may lead to inherent biases in the scores, with larger companies tending to score better than smaller companies, especially in emerging markets.
- Conflicts of interest for index providers that sell ESG rating services, with research showing that raters with strong index licensing incentives issue higher ESG ratings for firms with better stock return performance and those added to their ESG indexes, compared to raters with weaker licensing incentives.
These issues can make it difficult for investors to compare ESG performance reliably across sectors or markets.
ESG comparison: Correlations
| MSCI | S&P | Sustainalytics | CDP | ISS | Bloomberg | |
| MSCI | 35.7% | 35.1% | 16.3% | 33.0% | 37.4% | |
| S&P | 35.7% | 64.5% | 35.0% | 13.9% | 74.7% | |
| Sustainalytics | 35.1% | 64.5% | 29.3% | 21.7% | 58.4% | |
| CDP | 16.3% | 35.0% | 29.3% | 7.0% | 44.1% | |
| ISS | 33.0% | 13.9% | 21.7% | 7.0% | 21.3% | |
| Bloomberg | 37.4% | 74.4% | 58.4% | 44.1% | 21.3% |
Source: CFA Institute, Enterprising Investor, ESG Ratings: Navigating Through the Haze, August 2021
Why do ESG rating methodologies vary so widely?
It is generally accepted that different ESG ratings can tell very different stories about the same company. Much of this variation stems from differences in ESG ratings methodology, including the data sources used, the weighting applied to environmental, social, and governance factors, and the analytical approaches adopted by different providers.
As noted in a CFA Institute report published in 2021, this demonstrates the relative immaturity of the ESG ratings landscape and highlights the need for greater consistency and transparency. A separate CFA Institute study, also published in 2021, found that companies with high levels of disagreement in their ESG ratings faced higher risk premiums but also delivered stronger stock returns.
How are investors addressing ESG scoring issues?
Investors are responding in several ways:
- Pushing for improved data disclosure from companies to reduce inconsistencies.
- Engaging directly with issuers to validate and understand ESG performance.
- Using technology, including AI and advanced analytics, to assess ESG data independently.
These efforts, combined with emerging regulatory frameworks, aim to make ESG scores and ratings more transparent, comparable, and meaningful.
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Conclusion
ESG ratings have become important tools for assessing companies’ sustainability-related risks, opportunities, and performance. However, differences in methodologies, data quality, and potential conflicts of interest mean they should complement, not replace, independent analysis. Greater transparency, improved disclosure, and stronger regulation will be essential to make ESG ratings more reliable, comparable, and meaningful.
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