People have always sought to align their investments with their convictions. Today, that philosophy is gaining ground, with more investors than ever seeking ways to support—and profit from—companies that operate both “ethically” and “sustainably.” In fact, fund managers are now under increasing pressure to provide financial products that fulfill those requirements. But as demand ramps up, the ways in which companies are evaluated for their ethical governance and environmental responsibility are coming under scrutiny, making many people question the reliability of traditional sustainability ratings and rankings.
Below we explore the challenges around company sustainability ratings (also referred to as ESG ratings), and what companies can do to ensure a more fair (and accurate) assessment of performance in this area.
Can you really become more sustainable—and get the data to prove it? Yep, it’s possible. Ask us how we can do it for you.
What are company sustainability ratings?
To satisfy the demand for socially responsible investing, investment groups select companies for inclusion into specific portfolios based on their performance in three specific areas: environmental, social, and governance (ESG):
- Environmental—Clean energy, resource usage and waste, etc.
- Social—employee diversity, human rights, etc.
- Governance—Anti-corruption policies, shareholder rights, etc.
Sustainability ratings for ESG funds seek to provide a relationship between these three areas and financial performance; it is expected that high performers in these areas will minimize the risks associated with poor or pernicious decisions, bad politics, and egregious environmental practices, thus resulting in lower risk profile, better financial performance, and higher market valuations. Essentially, ESG investors hope such funds will help them reach their financial goals in ways that also align with their values.
The growth of ESG investing has led to a proliferation of sustainability rating systems to help guide financial managers and individual investors in their selections.
“What constitutes a virtuous company is woolly.” —Financial Times
Why do sustainability ratings and rankings vary so much?
[bctt tweet=”There is no single definition of what constitutes a so-called “socially responsible” company; therefore there are a variety of ways to rate and rank.” username=”iotacomm”]
There is no single definition of what constitutes a so-called “socially responsible” company; therefore there are a variety of ways to rate and rank. A 2017 report for the U.S. Department of Labor outlines some of the methods investors use to assess potential candidates, including:
- Selecting sustainability-themed companies
- Benchmarking performance on ESG factors as related to industry peers (without regard to whether or not the industry itself is performing up to par)
- Excluding investments connected to activities or industries deemed controversial
- Evaluating a company’s ability to manage ESG risks and opportunities
As Barron’s suggests, the financial “premium” that will be placed on seemingly responsible companies is likely to get higher in the future, however, “unfortunately, that premium may not have much to do with the actual sustainability of companies’ environmental, social, and governance (ESG) practices. ESG data still have plenty of inconsistencies and quirks, and there are significant differences in the ways various firms evaluate social responsibility.”
There are dozens of ESG ratings agencies—all with different methodologies and metrics. Why is that the case?
For one thing, capturing quantifiable metrics for ESG is difficult. Most ranking tools are qualitative, and many emphasize a company’s ability to manage its risk in the three named areas. Among the considerations in examining risk and exposure are relevance and materiality in terms of its impact on financial performance. In addition, sustainability rankings are often designed for a specific audience and use varying means of communications.
There are other complexities in developing a sustainability ranking, such as company size and geographic reach as well as sources of supply. The entire supply chain and production processes all add to further complicate efforts to formulate a measure of risk and exposure.
New approaches look to connect ESG ratings to actual financial performance and accounting reporting. To that end, there is some progress, including efforts by the Financial Accounting Standards Board (FASB) to improve transparency and disclosure. ESG ratings agencies like Sustainalytics and SustainAbility provide resources to improve the transparency and risk exposure of companies.
Key metrics in sustainability performance are environmental factors directly related to energy consumption, climate change, resource consumption, and waste. Energy consumption and efficiency performance benchmarking can be directly tied to carbon emissions and performance in greenhouse gas (GHG) offsets. Greater visibility into data regarding supply chains, production environments, waste, and resources can play a significant role in quantifying sustainability metrics.
In addition, the focus of ESG ratings is very broad, covering everything from social issues like minority hiring and advancement to environmental issues like reducing greenhouse gas emissions. That broad scope in combination with individual company-specific complexities further contribute to the qualitative approaches to assessing risks.
What can companies do to get more accurate sustainability ratings (& improve their sustainability scores?)
Company sustainability ratings are important to investors (and their clients), but ranking mechanisms lack specific and accurate information about a company’s sustainability practices.
At Iota, we have developed a data-driven approach to sustainability that focuses on environmental factors such as:
- Greenhouse gas emissions
- Health and safety of employees and building occupants (including air and water quality)
- Resource usage and waste
In contrast with the current qualitative approach of sustainability rating systems, our approach is dynamic and focused on quantitative metrics. Called the sustainability process blueprint, this approach uses the Internet of Things (IoT) to continuously monitor and catalog data about a facility and its operations. Our platform provides a framework for continuous process improvement by including near real-time data from IoT devices, and an analytics platform that curates data to provide insights, as well as the ability to benchmark progress toward goals and objectives.
The use of IoT devices enables data capture that is otherwise hard to reach and communicate back in a reliable fashion. By capturing data on energy and environmental conditions in this manner, you can monitor the performance and conditions of your assets and equipment, as well as building environmental conditions such as indoor air quality, water resources, and waste. While our focus may not include social and governance risk factors, the enhanced granularity into energy and environmental details provides a more comprehensive means in monitoring, measuring, and curating sustainability data.
This new sustainability process improves transparency and disclosure initiatives by providing a quantifiable and dynamic reporting platform that can help in both sustainability reporting and process improvement. This ability to quantify sustainability metrics makes it possible to devise more accurate environmental ratings for companies. It’s clear to everyone whether your efforts are having an impact, and how far you’ve come, because you have accurate data that can be examined over time.
The sustainability process blueprint also offers a framework for continuous process improvement, allowing you to find the best ways to optimize energy efficiency and sustainability. The data-driven analytics platform provides feedback loops that identify what energy savings initiatives work, and allows you to formulate a measurable approach to sustainability reporting. The ability to improve energy efficiency reduces operating costs while reducing greenhouse gas emissions. But perhaps even more important is that, by monitoring building indoor air quality in real time, healthier and happier employees become more productive. More productive employees can substantially improve financial performance while reducing risks.
Other agencies, such as the U.S. Green Building Council (LEED certification) and the International WELL Building Institute, provide useful approaches to improving energy efficiency, and parameters for the health and safety of buildings. These agencies have similar underlying methods, starting with being able to measure relevant components of energy and building viability. The ability to gain granular visibility into conditions is a great starting point for sustainability.
Need a partner who can help you get the data to improve your company’s sustainability rating?
If you’re interested in accessing reliable, accurate data for sustainability ratings, talk to us at Iota. We can help you develop a blueprint that will guide your company’s sustainability efforts, giving you real numbers to share with investors. Reach out and talk to us about what you’re trying to achieve—we’d love to help.