Managing misconceptions about ESG data
There’s a lot of misunderstanding of what goes into an ESG rating – and how they can be used. MSCI ESG Research’s Nadia Laine sets the record straight
Environmental Finance: MSCI ESG Research provides ESG ratings for more than 13,500 companies. How do you rate a company?
Nadia Laine: Our ESG ratings measure how exposed a company is to material industry risk and assess whether these risks are being adequately managed or mitigated. The overall rating indicates whether a company is a leader or laggard in its industry and is designed to flag outliers that might be more vulnerable to ESG issues.
Our ratings are highly industry specific, with unique model variants for each of the 150-plus GICs sub-industries, with each variant comprised of the four to eight key ESG issues we identify as being most relevant to the industry. We then measure the specific level of risk exposure to these issues at the company level, and review each company’s management systems, targets and any performance indicators to consider how it is managing that risk.
EF: Given the large number of ESG indicators, how do you determine which are the most relevant for a particular company’s financial performance?
NL: The selection and weighting of indicators for each industry are highly systemised, and we review them on an annual basis, starting with a quantitatively driven selection method and ending with a client consultation process, where we seek feedback from investors using our data on any new ESG issues we are proposing to add, and to any changes to weightings.
EF: Large companies are typically more able to collect and report ESG data. How do you avoid bias against smaller firms?
NL: It’s important that a robust ESG ratings model doesn’t rely solely on corporate disclosure. Around half of the average MSCI ESG Rating is built on business segment information, revenues and assets that we’ve mapped to dozens of data sources, such as water data from the World Resources Institute, or biodiversity data from The Nature Conservancy and WWF, safety statistics from the International Labour Organization, etc.
While large companies tend to have more resources for ESG reporting, they also often face high exposure to ESG-related risks due to the complexity of their operations and the size of their footprint. By offsetting disclosure against the level of risk exposure in the model, we’ve been able to address the size-bias challenge.
EF: How do you challenge the assumption by some investors that ESG ratings are ‘backward-looking’ and based on 12- or 18-month-old data?
NL: While any reported data, financial or non-financial, is by definition backward looking, the ESG Ratings model is explicitly designed to be forward looking, as it is designed to identify gaps in a company’s ESG risk management which may lead to vulnerability to future adverse events.
To correct a misconception: many of the datasets underlying the ESG Ratings model are in fact updated dynamically and reflect the latest information. Any data we get from news sources on a significant controversy, for example, or from the latest proxy filings are reflected in updated reports.
EF: Why is there not greater correlation among the ratings produced by different ESG rating providers?
NL: There are systematic reasons why ESG ratings can differ, the most important of which is that different ESG scoring approaches might aim to capture different things. For example, is the ESG rating a measure of the level of disclosure? Or is it designed to identify the level of exposure to ESG risk? Does it incorporate a wide range of ESG indicators, or is it only focused on what is most relevant for each sector? Is it an absolute signal, or is it industry relative? These factors can lead to significant differences in ratings.
EF: What is the relationship between MSCI ESG Ratings and financial performance?
NL: While past performance is not indicative of future results, recent research – published in the Journal of Portfolio Management – examined the ESG ratings of 1,600 stocks over 10 years. It found that companies with high ESG ratings demonstrated lower systematic risk profiles (i.e. lower costs of capital and higher valuations) and lower idiosyncratic risk profiles (higher profitability and lower exposure to tail risk), than companies with low ESG ratings. The study also found companies with the lowest ESG ratings were three times more likely to experience drawdowns over the previous 10 years.
For more information, see www.msci.com/esg-investing
- Environmental data
- Social data
- Governance data
- Indices/Exchange data
- Verification/certification data
What data do you provide?
MSCI ESG Research provides in-depth research, ratings and analysis of the environmental, social and governance-related business practices of thousands of companies worldwide. Our research is designed to provide critical insights that can help institutional investors identify risks and opportunities that traditional investment research may overlook. We leverage MSCI ESG Ratings for over 7,500 companies (13,500 total issuers including subsidiaries) and more than 650,000 equity and fixed income securities globally to create ESG scores and metrics for approximately 32,000 multi-asset class Mutual Funds and ETFs globally.
We aim to help investors integrate ESG across their entire investment process. Our broad product line supports clients' needs across major asset classes and provides them with a consistent way of looking at risk and performance from front to middle office. We have a flexible business model that enables clients to select the individual products and services they need and integrate to their own investment processes and methodologies.
Where and how do you source your data?
MSCI ESG Research utilizes hundreds of publicly available sources beyond corporate disclosure to inform ESG Ratings. Our data sources include more than 100 specialized data sets, company disclosures and more than 1,600 media sources. Source material includes corporate documents such as annual reports and quarterly filings, proxy filings, corporate social responsibility reports, securities filings, websites, and Carbon Disclosure Project responses; governmental data including central bank data and the Comprehensive Environmental Response and Liability Information System (CERCLIS); academic and NGO databases including trade and academic journals; and reports from and interviews with trade groups, industry experts, and non-governmental organizations familiar with the companies' operations and any related controversies. We also use a wide variety of sources to map micro-level risk exposure to companies' geographies of operation and business segments.
Who are the data users?
Over 1,300 institutional investors globally, including some of the largest asset owners and managers, are clients of MSCI ESG Research and Ratings. ESG Ratings and data from MSCI ESG Research LLC are also used in the construction of the more than 1,000 equity and fixed income MSCI ESG Indexes, which are provided by MSCI, Inc.
What are the key attributes that differentiates the data you offer?
The ESG Ratings are not a disclosure-only assessment. On average, voluntary company ESG disclosure accounts for about 35% of a company’s ESG rating. While greater transparency of meaningful data is still needed and desired for the most accurate evaluation of a company’s ESG performance, we have found that voluntary reporting on its own is not sufficient for investors to assess companies’ potential ESG risks and opportunities. Alternative datasets are used to corroborate and balance the views presented by voluntary disclosure and provide institutional investors an objective view of a company’s ESG risk profile.
MSCI ESG Research is the first in the industry to provide a fully integrated set of ESG research and analysis tools covering the most common fixed income issuer types, including corporates, sovereigns, supranationals, agencies, and covered bonds.
In addition, MSCI’s Analytics products offer institutional investors an integrated view of risk and return. Our research-enhanced content and tools help institutional investors understand and control for market, credit, liquidity and counterparty risk across major asset classes, spanning short, medium and long-term time horizons. MSCI's Analytics platform includes MSCI Barra multi-factor models, pricing models and methodologies for performance attribution, MSCI RiskMetrics models for statistical analysis such as VaR, and tools for security analysis, portfolio optimization, back testing and stress testing. MSCI Beon™ allows clients to interact with their data and analytics alongside MSCI’s third-party content all in one place, providing clients with greater efficiency and flexibility.
MSCI #ESG Ratings provides insight into ESG risks and opportunities. How do #ESG Ratings work? What are the significant ESG risks? What does a poor rating look like? Learn more. https://www.msci.com/esg-ratings