ESG rating agencies play a key role in assessing the sustainability performance of companies and therefore have a major influence on corporate financing and company valuation. With the help of comprehensive ESG ratings, the agencies analyse how sustainable a company’s business practices are and prepare corresponding overall assessments. These are increasingly being used by investors as an important criterion for their investment decisions and as a basis for structuring financial products. Other stakeholders rely on the judgements of ESG rating agencies to make business decisions, for example in relation to supply chain relationships. A poor ESG rating can therefore have a negative impact on a company’s reputation and affect its financial performance.
More and more companies have recognised the risks associated with weak ESG ratings in recent years. Accordingly, more and more people on the corporate side are analysing the ratings issued by the agencies. In doing so, they are also increasingly focussing on the position of their own company in relation to the industry or individual competitors. This can lead to a lack of understanding and resentment among companies, for example when a comparatively negative overall assessment cannot be understood in detail due to the complexity of the ratings or when the company’s self-image with regard to its own sustainability performance differs significantly from the corresponding assessment of the ESG rating agencies. In moments like these, however, it is important to keep a cool head and avoid some common mistakes when dealing with ESG rating providers.
As a consulting agency, cometis AG supports companies from various sectors in optimising their ESG ratings and engaging in dialogue with ESG rating agencies. The focus is usually on the most influential providers on the capital market. These include MSCI, ISS ESG, Sustainalytics, S&P Global, Refinitiv and Moody’s. These agencies are currently at the centre of attention for investors and other stakeholders. As part of our consulting activities, we have analysed numerous ESG ratings in detail over the past seven years and exchanged views with many analysts and representatives of the ESG rating agencies on the approach to the analysis and the specific criteria for the ratings. We have also analysed the methodologies and a large number of assessment criteria of ESG rating agencies as part of the Global ESG Monitor. Based on our experience from previous years, we present below a selection of mistakes that companies should definitely avoid when dealing with ESG rating agencies.
1st Mistake: Closing your mind to the topic and remaining inactive
ESG rating agencies rate companies even if they actually want to avoid the topic and consciously decide to remain inactive. The agencies will not be deterred if their possible preliminary enquiries about sustainability performance in individual areas of the company remain unanswered or if companies are extremely unwilling to co-operate. The large and influential rating providers in particular will definitely issue a rating once they have chosen a company for it. In order to ultimately prevent companies from falling further and further behind their competitors in the assessment of their sustainability performance, they should actively address the topic of ESG ratings and the possibilities for ESG rating optimisation.
2nd Mistake: No prioritisation
In 2020, the President of the World Business Council for Sustainable Development estimated that there were over 600 ESG ratings worldwide (WBCSD, 2020). Although there have been numerous consolidations within the industry in recent years, there are still too many different providers to avoid prioritisation. Especially as the individual ESG ratings are usually very complex and focus on different topics. When prioritising, particular consideration should be given to which rating agencies receive the most attention both on the capital market in general and from the company’s specific stakeholders.
3rd Mistake: Disregarding the agencies’ focus areas
Companies and other capital market players often underestimate the extent to which ESG ratings differ in their focus areas. Usually, the influence of E issues is overestimated and the importance of S and G issues underestimated. For example, ESG rating providers clearly focus on the “S” area, particularly in the case of companies from the pharmaceutical industry or the gambling sector. Accordingly, it would be of comparatively little benefit to companies from these sectors, at least in terms of their ESG rating, if they were to focus entirely on climate and environmental protection. It is therefore important to always consider the individual focus areas of the agencies.
4th Mistake: Underestimating the complexity of the ratings
The complexity of the individual ratings is also repeatedly underestimated. Within the “E”, “S” and “G” categories, the rating agencies generally assess performance with regard to a whole series of subordinate topics. In the “S” area, for example, emphasis might be placed on the topics of “Equal opportunities and non-discrimination”, “Health promotion”, “Human rights”, “Stakeholder dialogue”, “Product safety” and “Working conditions in the supply chain”. The assessment of an individual topic area is then usually based on the allocation of points for various individual criteria. Depending on the topic area, these can be numerous, weighted differently and vary greatly in terms of content between the rating providers. Although the rating agencies have become increasingly transparent in recent years with regard to their methodology and precise assessment criteria, their explanations in the rating reports and their separate supporting documents are often very extensive and relatively complicated. In order to gain a truly precise understanding of an ESG rating, it is therefore necessary to delve into the respective complexity and carefully analyse all available documents.
5th Mistake: Expecting results too quickly
With regard to a targeted improvement in one’s own ESG rating, it is usually unrealistic to expect significant progress or significantly higher ratings in the short term. As a general rule, improving the sustainability assessment requires some effort and a time investment that should not be underestimated. A careful analysis is therefore first required for each rating in order to identify the greatest levers for a rating improvement. Clear to-dos then need to be defined, such as the collection of new diversity KPIs, the formulation of new CO₂ targets or the introduction of a new health management system. The next step is to prepare and coordinate the appropriate external communication, for example as part of the sustainability report. And even once these steps have been taken and the new services have been communicated, it can sometimes take a while before the rating agency analysts turn their attention to a company again. For example, many agencies only update their company ratings once a year. Overall, perseverance and determination are therefore required when dealing with ESG rating agencies and improving ESG ratings.
6th Mistake: Not checking the analysis of the agencies
Time and again, agency analysts overlook relevant data and information, even though they have been precisely prepared and published in the sustainability report or on the company website. Unfortunately, the exact process of analysis is generally not very transparent. It is therefore difficult to assess the extent to which the analysis is automated, for example, or whether it is simply based on a manual search for specific keywords. It is also not clear how much time is actually spent on analysing a company. However, one thing is clear: errors occur regularly, and these can have a significant impact on the overall assessment. For this reason, every new ESG rating that a company receives, as well as every update of an existing ESG rating, should always be carefully reviewed and, if errors are discovered, dialogue with the agencies should be sought.
7th Mistake: Avoiding dialogue with the agencies
If mistakes are discovered in the rating agency’s analysis, direct dialogue should always be sought with the agency or the responsible analysts. In the case of the larger rating agencies, this is possible via their own online portals. There, companies have the opportunity to give the analysts feedback on their ratings. At least the more influential providers have already developed a structured process whereby feedback can be given in great detail – at the level of individual criteria. A company should always include a reference to where exactly a value or information can be found that is relevant for a specific individual criterion. Overall, a careful review of the analysis and the creation of feedback are relatively time-consuming, but the effort is usually worthwhile and often leads to a (significant) improvement in the ESG rating. In general, companies should therefore not shy away from entering into dialogue with rating providers, especially as they are usually open (and sometimes even grateful) for information on errors in their analysis.
8th Mistake: Not using the expertise of specialists
When dealing with ESG rating providers, it generally saves companies a lot of work, uncertainty and loss of time if they rely on the expertise of specialists. It is of course valuable for a company when the ratings can be analysed more quickly and precisely with the help of an ESG rating specialist and when key levers for possible rating improvements can be identified. The dialogue with the agencies can also be very exhausting for companies without experience. The rating providers’ portals – which serve as an essential platform for dialogue with analysts – are sometimes quite confusing and user-unfriendly. Without knowledge of how analysts work or the exact requirements for the fulfilment of individual criteria, misunderstandings can quickly arise between companies and rating agencies. For an effective and targeted approach to ESG rating providers, it is therefore advisable to utilise the experience and knowledge of corresponding specialists.
9th Mistake: Neglecting your own ESG reporting
ESG rating agencies primarily analyse the annual ESG reporting / the annual sustainability reporting of companies. In this respect, the ESG report / sustainability report plays the central role. Experience has shown that analysts scrutinise this document most thoroughly. Nevertheless, ESG reporting can also be kept up to date on an ongoing basis with the help of the company’s own website. For example, if the company adopts a new ESG policy or reports a new ESG KPI, the corresponding document or indicator can be made available on the website before the next sustainability report is published. The information on the company website is also included by the rating providers in their assessments. When dealing with ESG rating agencies, it is therefore important to take a structured approach to your own ESG reporting – especially with the help of a stakeholder mapping, a stakeholder engagement process and a materiality analysis – and then continuously optimise it. In general, it has been repeatedly observed that the more ESG information companies proactively provide as part of good ESG reporting, the easier and less time-consuming it will be to deal with ESG rating agencies later on.
By avoiding mistakes when dealing with ESG rating agencies, companies can ensure that their ESG performance is assessed appropriately and that they take effective measures to improve their ESG ratings. In addition, the knowledge gained in this context can also be used to sharpen the company’s own ESG strategy and the general further development of its own ESG reporting. In recent years, we have often found that careful rating analysis, precise communication in the sustainability report and skilful dealings with rating providers in particular can lead to significant rating improvements. cometis AG has developed its own tool for the systematic process of ESG rating improvement, the ESG Rating Impact Tool. This tool and our experience from many ESG rating projects form the basis for our cooperation with our clients. Further information can be found on our website under ESG Rating Advisory or Rating Impact.
Do you need further advice on dealing with ESG rating agencies? Then cometis is the right contact for you: We will be happy to answer your questions by telephone (+49 611 20 58 55 18) or by e-mail (diegelmann@cometis.de)!