What Is ESG rating and categories

In the past, all a company needed to succeed was a high-demand product, solid financial reports, and a strong HR team to keep everyone motivated. But things have changed. Now, customers care about brand reputation, employees value how much the company supports them, and investors are focusing on ESG criteria. According to PWS, by 2026, investors will allocate $33.9 trillion based on ESG ratings.

So, what exactly is ESG, and how is the rating determined? Let’s break it down ⬇️

What is ESG?

ESG stands for Environmental, Social, and Governance. These criteria were outlined by former UN Secretary-General Kofi Annan and are designed to assess how sustainably a company operates.

Sustainable business development is a way of running a company that takes into account economics, society, and the environment. It's about trying to meet the needs of today without harming future generations.

ESG criteria emerged in response to global challenges like climate change and rising inequality between wealthy and poor nations. Major brands have started to think beyond profits and consider how their actions impact the world around them. 

The point of the approach is to make the company's work more friendly to the environment, people and the world. Investors want to cooperate with such companies. 

What is ESG Categories

Let's see what can be done in the company to improve the situation. Here are some ideas:

E – Environmental criteria
Environmental criteria look at how a company cares for the environment. For example:

• How it uses natural resources
• Reduces pollution
• Manages water and electricity consumption
• Disposes of waste

A company can reduce pollution by optimizing transportation routes for delivering its products. For example, using electric vehicles or more fuel-efficient transportation helps significantly lower carbon emissions. This also contributes to improving air quality and reducing the environmental footprint.

S – Social criteria
Social criteria focus on how a company treats people, from employees to suppliers, customers, and partners. For example:

• Does it prioritize employee health?
• Protect human rights?
• Provide fair wages and working conditions?
• Invest in professional development and equal pay regardless of gender or ethnicity?

The ideal scenario is where employees work in safe, comfortable environments without excessive overtime, and their rights are fully protected.

G – Governance criteria
Governance criteria assess how transparent and ethical a company’s leadership is. For instance:

• How effective is the CEO?
• Are executive salaries justified?
• Are shareholder rights protected?
• How rigorous are the company’s audits?

A well-run company takes steps to combat corruption and publishes clear financial reports.

Who evaluates ESG compliance?

Independent rating agencies, such as MSCI, Sustainalytics, SAM, and ISS ESG, are responsible for assessing companies on ESG performance. Each agency has its own evaluation criteria, but they generally consider the following:

Assessment of Environmental criteria:

• Carbon Emissions: Companies can reduce their carbon footprint by optimizing logistics and production or offset emissions through environmental initiatives like planting trees or restoring wetlands. Achieving net-zero emissions or even negative emissions (removing more carbon than they emit) is the goal.
• Energy Efficiency: Solar, wind, and water are the preferred energy sources. Companies can also install energy-efficient lighting and solar panels to reduce electricity consumption.
• Resource and Waste Management: Companies can save water by installing motion-sensor faucets and reduce plastic use by switching to reusable cups. They also can sign contracts with local recycling companies to deal with plastic, paper and metal waste.

Assessment of Social criteria:

• Diversity and Inclusion: Assessments include gender and ethnic diversity, as well as working conditions for employees with disabilities.
• Product Safety and Quality: Does the product meet quality standards, such as ANSI certification? ANSI accredits standards developed by government agencies, consumer groups, and companies. These standards make sure that products have consistent features and performance and that they're tested in the same way.
• Employee Welfare: This includes workplace safety, employee relations, wages, and benefits.

Assessment of Governance criteria:

• Ethical Leadership: This evaluation checks how honest and transparent the company’s leadership is. Managers should make the right decisions and not hide information. Honest leadership helps build trust and success.
• Shareholder Rights: It also looks at whether voting is fair and if all shareholders, even those with few shares, have their rights protected and can influence important decisions.
• Anti-Corruption Measures: The company must prevent employees from using their position for personal gain. Without a strict anti-corruption policy, the company will not receive high scores.
• Executive Compensation: Managers' salaries and bonuses should be tied to the company's long-term goals. If the company aims to improve environmental responsibility, executive compensation should depend on their contribution to achieving these goals, such as reducing emissions or using renewable energy.

Companies that openly publish ESG reports and focus on long-term sustainable growth tend to score higher on these evaluations.

GRI, CDP and SASB certificates

The standards allow us to assess the level of compliance of projects with modern requirements of a long-term strategy.

GRI —  Global Reporting Initiative helps businesses, governments, and other organizations understand and talk about their impact on things like climate change, human rights, and corruption.

CDP — The Carbon Disclosure Project helps companies measure and disclose their environmental impact. They have a global system called the CDP Online Response System that companies use to tell people about their sustainable practices. CDP uses information from this system to compare companies' progress in areas such as climate change, forest protection, water security and supply chains.

SASB — The Sustainability Accounting Standards Board develops sustainability accounting standards. SASB standards cover a range of environmental, social and governance issues that are important for financial performance.

How ESG ratings are assigned

The S&P Global ESG Scores, or SAM for short, is one of the toughest out there. It's a 100-point scale. To evaluate the ESG rating, the rating agency has to interact directly with companies and it's based on a deep dive into all sorts of issues related to sustainable development. 

The ESG rating process involves four steps:

1. Data Collection: Rating agencies gather data from public reports, press releases, surveys, and interviews. They analyze data across all three categories: environmental, social and governance. For example, carbon emissions and energy efficiency.

2. Developing Criteria: Criteria are created for each of the three ESG pillars: environmental, social, and governance.

3. Evaluation: Companies are rated across these criteria using a mix of quantitative and qualitative measures.

4. Industry Comparison: Companies are compared with their peers to assess their relative position.

Rating agencies not only use different methods to gather information but also apply various scales to evaluate companies. To help you navigate these scales, let’s break down each one ⬇️

The rating agencies Moody’s ESG Solution, Bloomberg ESG Disclosure, and S&P Global ESG Evaluation use a 0 to 100 scale. The higher a company’s score on this scale, the better it meets ESG criteria.

The gradation is as follows:

• 90-100 — Leading ESG compliance, minimal risks.
• 75-89 — Very good compliance, high level of responsibility.
• 60-74 — Good level, but room for improvement.
• 45-59 — Average level, needs further development.
• 30-44 — Below average, the company faces challenges.
• 15-29 — Low level, significant gaps in ESG policy.
• 0-14 — Very low level, high risks for investors.

The rating agency Sustainalytics uses a reverse 40-point scale, which reflects the level of risks for investors associated with the company’s ESG compliance. The lower the score, the fewer the risks for investors.

The gradation is as follows:

• 0-10 points — Negligible Risk.
• 10-20 points — Low Risk.
• 20-30 points — Medium Risk.
• 30-40 points — High Risk.
• 40+ points — Severe Risk.

The rating agency MSCI ESG Rating uses a letter scale from CCC to AAA.

The gradation is as follows:

• AAA — ESG leader, excels in addressing challenges.
• AA — Very good ESG performance.
• A — Good performance but with room for growth.
• BBB — Average ESG compliance.
• BB — Below average, with ESG issues.
• B — Weak performance with significant gaps.
• CCC — Lags significantly, high risk, and poor ESG management.

For example, IKEA's ESG meaning is a 98/100, according to CSRHUB.

Is it true that ESG strategy is a scam?

For all their initial appeal, ESG ratings  don't always mean a company is actually doing the right thing when it comes to sustainability.

For example, Elon Musk literally tweeted that “ESG is a scam.” You see, Tesla, which makes solar panels and electric vehicles, didn't even make S&P's list of the 500 largest ESG companies.

However, not many were in a hurry to support Musk’s decisive attitude. Kunal Shah, managing director of iCapital, explained that “In our view, ESG is more of a defensive strategy.”

How to implement ESG principles in a company

ESG principles require significant changes, and it's best to implement them gradually. For example, start by improving waste management practices, then focus on employee well-being. Over time, this step-by-step approach will lead to substantial progress.

1. Assess Current Practices: Conduct an audit of your company’s current practices in environmental sustainability, social responsibility, and corporate governance.

2. Choose a Focus: Pick one area of ESG to focus on first—whether it’s improving environmental sustainability or enhancing governance practices.

3. Develop an Implementation Plan: Create a detailed action plan with clear deadlines and assign responsibilities.

4. Foster an ESG Culture: Train employees on ESG principles and emphasize their importance to the company’s success.

5. Monitor Progress: Regularly track your company’s progress toward its ESG goals, publish reports on the results, and adjust the strategy as necessary.

Top companies leading in ESG: corporate case studies

Let’s take a look at three companies that have implemented strong ESG strategies:

Microsoft

ESG Risk Rating: 14.2 by Sustainalytics
Assessment: Low ESG risk for investors

Microsoft aims to be carbon-negative by 2030 and plans to remove all its historical carbon emissions by 2050. They’re also investing $1 billion to accelerate climate solutions and making their products more accessible to people with disabilities.

Kering

ESG Risk Rating: 10.0 by Sustainalytics
Assessment: Low ESG risk for investors

The luxury group behind brands like Gucci and Yves Saint Laurent is committed to reducing its environmental impact by 40% by 2025. The company also leads the way in gender equality, with 57% of leadership roles held by women.

Johnson & Johnson

ESG Risk Rating: 20.1 by Sustainalytics
Assessment: Medium ESG risk for investors

J&J is working to cut greenhouse gas emissions by 44% by 2030 and already sources 87% of its electricity from renewables. They also provide healthcare solutions to underserved communities, having trained 40,000 healthcare workers in low-resource areas.

The Bottom Line on ESG

• ESG helps assess how well a company addresses environmental, social, and governance challenges.
• ESG-ratings matter to investors, employees, and customers, as they indicate a company’s long-term sustainability and ethical commitment. Independent agencies evaluate and assign these ratings based on a variety of criteria.
• Ultimately, companies that embrace ESG are not just improving their bottom line—they’re making the world a better place.