Ratings provided by rating agencies are backed by extensive ESG expertise and resources, says Arina Kok.
CONSUMERS, stakeholders and investors are increasingly using metrics to evaluate the ESG performance of businesses to ensure that they are steered towards long-term sustainability and growth.
From ESG performance measures and sustainability disclosures, they can assess the severity of the impact of ESG issues on business performance, risks and long-term growth prospects, that is not captured by traditional financial analysis.
ESG metrics can serve as a risk management tool on other important matters, beyond financial performance, that companies are scrutinised for, such as environmental conduct, labour practices and corporate governance.
Companies that prioritise sustainability are likely to generate sustained profits and benefit investors in the long run; since 2014, the ESG-focused FTSE4Good Bursa Malaysia index has outperformed the benchmark FBM KLCI index by 5.6%, said Bursa Malaysia.
The FTSE4Good assessment criteria takes into account companies’ exposure across the full spectrum of material ESG risks which are classified into 14 ESG themes and supported by more than 300 detailed quantitative and qualitative indicators.
FTSE Russell carries out the ESG assessment independently, using publicly available information, to assess whether companies have disclosed measures in mitigating their material ESG risks.
Bursa Malaysia, in collaboration with FTSE Russell, is making available ESG scores of Malaysian listed companies, to facilitate investors in incorporating ESG assessment via a trusted and internationally recognised methodology.
Before they decide to invest, investors sometimes conduct negative screening where they exclude certain companies based on negative criteria, from their investment universe.
These negative factors include controversial practices or serious misconduct, for example, production of harmful products such as weapons or tobacco, and the avoidance of industries associated with harming the environment.
Meanwhile, positive screening involves the selection of companies based on positive criteria such as a minimum ESG score or the offering of sustainable products.
Investors should monitor a company’s ESG reported data over time, says Phang Oy Cheng.
The integration approach considers ESG information alongside traditional investment data to help identify potential risks or a competitive advantage such as exposure to the green economy.
Investors also engage with portfolio companies to improve business strategies, risk management and ESG performance.
Under the thematic investment approach, focus is placed on well-established environmental themes or other frameworks such as the United Nations Sustainable Development Goals.
ESG rating agencies which include Morgan Stanley Capital International (MSCI), Sustainalytics and Refinitiv, provide a quick overview of a company’s ESG performance.
The ratings provided by rating agencies are backed by extensive ESG expertise and resources, and are often applied across multiple companies, which gives a point of benchmark against other companies, said Ernst & Young Consulting Malaysia Climate Change and Sustainability Services leader, Arina Kok.
However, different ESG rating agencies may use different approaches to their methodology, hence cross rating comparisons may not be accurate.
Rating agencies typically collect ESG information publicly disclosed by companies through their sustainability or corporate social responsibility as well as annual reports, websites, other public sources and even through direct contact with the companies.
The data gathered is examined and standardised by using a set of 120 indicators that cover various aspects of the company’s ESG performance in terms of, among other things:
> Carbon emissions, climate change impacts and pollution.
> Discrimination, diversity and community relations.
> Takeover defense (actions by managers to resist takeovers), staggered boards (consisting of different classes of directors) and independent directors.
Companies that do not disclose such data will be penalised by the rating service.
Investors should monitor a company’s ESG reported data over time – three to four years – to determine the true performance in ESG, or lack of it, said KPMG in Malaysia, head of sustainability advisory, Phang Oy Cheng.
When referring to different data provides, ESG performance can differ based on the type of indicator assessed.
Due to their specific nature, the ESG metrics may not capture the full scope of a company’s ESG performance.
Some ESG issues such as human rights or impact on the community, are less quantifiable and may not be easily understood through ESG metrics.
Main data providers include MSCI ESG Ratings, Sustainalytics ESG Risk Ratings, FTSE Russell’s ESG Ratings, ISS Ratings and Rankings, CDP Climate, Water and Forest Scores, S&P Global ESG Score and Moody’s ESG Solutions Group.
By reading through company annual and sustainability reports, investors can analyse a company’s ESG disclosures against relevant ESG frameworks for transparent disclosures and performance in specific areas.
These frameworks include the Global Reporting Initiative, Taskforce on Climate-Related Financial Disclosures and Sustainability Accounting Standards Board.
Using frameworks is another approach to provide a standardised method of reporting on sustainability-related matters, allowing investors to assess the business activities, gaps and emerging ESG issues that companies have considered.
In terms of consistency, the issue here is that different companies may report on different areas within environment, social and governance topics.
Companies may not report consistently and comprehensively across all subject areas.
Currently, there does not exist any industry benchmarks nor consistent performance measurement metrics, which makes it tricky for investors to compare the performance of one company to another, even within the same industry.
This challenge is amplified, given that most ESG data is self-reported by companies, which can lead to potentially biased information and gaps in data availability and quality.
There is lack of information on how specific metrics are defined and the methodologies used to derive the data being reported, thus limiting comparability between companies.
There is no ‘one size fits all’ approach in assessing a company’s ESG performance.
Investors should carefully consider their personal investment profile and goals to determine whether implementing ESG methods align with their investment strategies.
