November 9, 2022, Zurich, Switzerland
Responding to six challenges for ESG ratings by SustainAbility Institute by ERM
The SustainAbility Institute by ERM has recently identified six big challenges facing the ESG ratings landscape and kicked off their annual survey to dig deeper into the issues, noting that “increasing ESG scrutiny makes current Rate the Raters study even more crucial.”
If you’re an investor or an issuer navigating the ESG space, this is your chance to provide feedback on ESG ratings and data in practice. The Rate the Raters Survey 2022/2023 is now open, and results will be available early next year.
As we await the insights from the latest study, we want to take the opportunity to address the six challenges and explain how RepRisk’s unique research approach circumnavigates them.
# Challenge 1: ESG Ratings Are Expensive and Bothersome
The Institute says: In an effort to construct more complex rating methodologies, the process of collecting ESG information from companies has become increasingly expensive and time-intensive for corporate sustainability professionals. This in turn impacts the cost of ESG ratings, and the onus is on the providers to demonstrate they are worth the cost.
RepRisk approach: Unlike many providers in the ESG ratings space, RepRisk relies on an outside-in approach to data collection. We intentionally exclude company-self disclosures to serve as a reality check for how companies conduct their business around the world – do they walk their talk when it comes to human rights, labor standards, corruption, and environmental issues? Our data is captured daily from 100,000+ public sources and stakeholders, in 23 languages, using a combination of machine learning and human analysis. While technology enables the speed, scale, and breadth of our dataset, our human analysts ensure the quality and integrity of our data. Hence, there are no ESG data requests or questionnaires to fill out for corporates – we let technology do the heavy lifting and provide daily updated, “due diligence grade” data to our clients.
# Challenges 2 & 3: ESG Ratings Contradict Each Other | ESG Rating Divergence Is Often Intentional
The Institute says: ESG ratings of companies diverge significantly from one another, making it difficult for investors to evaluate ESG risk and performance of both individual companies and entire portfolios. Importantly, that divergence is both intentional and unintentional; the intentional part attributed to the ‘secret sauce’ of each individual provider, while the unintentional part largely the result of differentiation in access to data points as well as their interpretation.
RepRisk approach: For investors, the intentional part of the divergence is key to differentiating investment strategies in the marketplace. In order to understand the underlying ESG issues, however, users require both the raw data points and the aggregation methodology/objective. RepRisk offers both.
Our dataset has one clear goal: to identify and assess ESG and business conduct risks. Our methodology has always been fully transparent to our clients and partners, and last year, we took the unprecedented step of making our methodology available publicly on our website. This includes our research approach, research scope (including definitions of our 102 ESG risk factors), research process, and the algorithms behind our risk metrics. It also provides sample data and live code for users to customize their own ESG scores here.
Importantly, RepRisk does not use an industry-specific or country-specific weighting scheme when analyzing the individual ESG risk incidents related to companies. We evaluate impact and materiality at the level of ESG risk incidents. As outlined in our methodology, we look at the underlying severity, source, and novelty of the risk incident – and provide this information to our clients. This ensures that users can fully understand the data and how it’s aggregated, and can therefore align it with their objectives and strategy.
# Challenge 4: ESG Ratings Are Not Evenly Distributed
The Institute says: ESG ratings based on self-disclosures are unevenly distributed across the company universe. They are highly concentrated in public companies, companies trading on major exchanges, and those with higher market caps. This deprives investors of decision-useful insights and results in significant data gaps for certain sectors and markets.
RepRisk approach: RepRisk’s research approach is issues- and events-driven, i.e. we search for ESG issues that are based on our research scope and capture ANY company that is associated with this ESG issue – whether this company is big, small, public, private, and across all sectors and geographies. Every day, an average of 50 new companies with ESG risk are added to the RepRisk dataset. The result is the industry’s largest coverage. Notably, RepRisk is the only ESG data provider that systematically covers private companies (currently 215,000+), emerging and frontier markets, and 65,000+ infrastructure projects such as dams, pipelines, and factories.
# Challenge 5: ESG Ratings Are Not Predictive
The Institute says: Investors are concerned with not only where companies have been, but where they are going, and looking for ESG signals to help predict future sustainability success and risk management capabilities. While credit ratings have historically been an excellent predictor of credit risk, ESG risk has so far proven to be more complex.
RepRisk approach: RepRisk’s unique-to-the-industry approach was born out of our history in credit risk management. Our risk incident data has been independently found to provide both risk management and alpha generating signals: for risk management, the number of risk incidents a predictor for future incidents, and for alpha, jumps in our metrics associated with negative abnormal returns. Clients can access a consistent time series of 16+ years high-quality data that can be used for rigorous back-testing and quantitative analysis – our data is generated point-in-time and not back engineered to match security prices.
# Challenge 6: ESG Ratings Are Unregulated
The Institute says: The ESG ratings landscape to date has been largely unregulated, although this is changing quickly with rules incoming from the US Securities and Exchange Commission and the European Commission’s Sustainable Finance Strategy. Regulation is expected to bring much needed standardization and consistency, and is likely to address some of the unintentional ESG rating divergence previously mentioned above.
RepRisk approach: As the ESG landscape matures, RepRisk welcomes the move towards more transparency in the ESG industry – we encourage providers to disclose their underlying methodologies, list of services provided, and their level of independence to avoid conflicts of interest. This will help ensure that users can align their strategies with the right data for the right use case. RepRisk’s methodology is available on our website.
Founded in 1998 and headquartered in Switzerland, RepRisk is a pioneer in ESG data science that leverages the combination of AI and machine learning with human intelligence to systematically analyze public information and identify material ESG risks. RepRisk’s flagship product, the RepRisk ESG Risk Platform, is the world’s largest and most comprehensive due diligence database on ESG and business conduct risks, with expertise in 23 languages and coverage of 230,000+ public and private companies and 65,000+ infrastructure projects. For more than a decade, the world’s leading financial institutions and corporations have trusted RepRisk for due diligence and risk management across their operations, business relationships, and investments. Find out more on reprisk.com.