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ESG Scores – What Are They and How Is It Calculated?

Across almost every sector, environmental, social, and governance issues are becoming widely recognised. As a result, having the scope to manage risks associated with ESG, as well as its opportunities, can help a business to thrive in a competitive world. However, for a business to understand its ESG liability, it is important that it understands its ESG score, how it is calculated and why it is so important.

What is an ESG Score?

A company might consider its ESG score to be material, but it could be hugely important to a company’s stakeholders. An ESG score makes it possible for companies to assess and understand their performance internally and across the wider corporate ecosystem. The score is based on how a company is seen to be performing and behaving when it comes to reporting environmental, social, and governance issues.

There is a clear gap between reality, and what is seen to be happening when it comes to ESG. Although a business may have strong policies in place to deal with the likes of carbon emissions or the reduction of waste, if this information is not readily available in the public domain, it will have no positive impact on its ESG score.

Likely, the stakeholders won’t clearly understand the ESG position of the company if the score is not an actual reflection of how the company is performing. While ESG scores are only a measurement of how certain behaviours are reported, the scores hold value when it comes to identifying gaps between the internal reality and what is perceived externally.

Where a reality gap is seen, it poses a risk, and this makes it especially important for the business to report thoroughly on ESG factors as this will help to create an accurate ESG score.

Why Do You Need an ESG Score?

Essentially, an ESG score is something that can make a business take action. It should shift the focus of stakeholders onto their ESG liability and where opportunities and risks might lie. Furthermore, it will help them to determine how the business is performing against the broader sector.

This could mean that a business might need to take a new approach to corporate strategies as a result of ESG performance. Perhaps, their corporate reporting is more detailed concerning ESG issues to take advantage of the rise in sustainable investing. Maybe they will miss out because they are not doing enough to promote their ESG credentials.

There are a whole number of reasons why a business needs an ESG score beyond understanding its ESG position. A large increase in ESG investing could be one of the more significant reasons as investors are looking for portfolios that consist of sustainable assets.

There is a strong link between good performance on material ESG issues and financial performance. ESG scores make it possible for independent and institutional investors to determine which companies are going to deliver good returns. Essentially, asset managers are now seeing a good ESG rating as an indication of healthy profits.

Benefits Of A Good ESG Score

A satisfactory ESG profile not only sits well with other stakeholder groups but also employees looking at the environment, social, and governance policies to see if they match with their own beliefs. Those seeking a new job can look at an ESG score to determine whether companies are right for them. If businesses put focus on scoring well, they could attract the best talent. In addition to this, campaign groups and NGOs are also unlikely to focus on companies that have a high ESG score when looking to expose unsustainable practices.

From an internal perspective, an ESG score that comes from adding weight to ESG liabilities on a broad range of issues, as well as specific factors that relate to its sector, will give businesses the scope to seek out ESG opportunities and potential risks. For those areas where the business achieves a good score, they might equate to factors that underpin its purpose and so, and this will make them more financially viable. As an example, an airline that reduces its fuel consumption is going to have more of a positive impact than it would for a bank. Similarly, if it gave some of its profits to a homeless shelter, that could sit well with those who do the same thing.

The reality is that an ESG score is not going to have an impact on behaviours whereby people follow crowds. Press releases that relate to environmental activities are not a precursor for successful ESG policies. However, it is important to make sure that their ESG credentials are communicated correctly as this will help to close the void between reality and perception.

It is not just the role of the team to ensure that stakeholders understand the ESG position of the company. Essentially, everyone who works for the company becomes an ambassador of the company and its ESG beliefs and goals.

How is an ESG Score Calculated?

For every business, there is a need to put a figure on its ESG performance and as a result, a variety of scoring systems have been created. This has resulted in bespoke ESG scores being created for companies by analysing companies using a range of calculation processes. However, these ESG systems can be very subjective, much in the same way that ESG scoring is used to measure perception.

Those methodologies that are opaque are making it difficult for businesses to determine how their score has been created and this means that the score can differ based on who they have employed to carry out the work.

A reliable scoring system has to offer consistency but also accuracy and it needs to be objective. Therefore, it should be able to deliver scores that can be compared across geographies and sectors while it should cover all stakeholder perceptions.

The reality is that ESG scores are commonly determined by the self-disclosure of data by companies, although some of this data can be partial. To offer accurate scores and to reflect rapid development concerning ESG issues, this should include real-time analysis of a range of factors such as online and broadcast news, publicly available print, and even social media content. It should cover everything from blogs to NGO communications and everything else in between.

What this means is that ESG scoring should include human oversight with machine learning as well as natural language processing. As a way of removing subjectivity, scores should be aligned with benchmarks as this will make it possible to make use of a detailed reporting framework of issues related to ESG based on sectors.

The Sustainability Accounting Standards Board (SASB) is considering the importance of sustainability metrics and is developing accounting standards to coverthis. This is enabling companies to provide reports on finance-related ESG issues methodically.

When these accounts form part of their annual reports, businesses can deliver accurate ESG scores that will become more useful for making investment decisions and implementing corporate governance.

Essentially, when an ESG score is more reliable and the more consistent the calculation, the greater the impact it will have on performance in the long term. As a result, businesses can become more sustainable through the management of ESG risks and opportunities that help to drive corporate governance and impact investing.

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