Three steps to improve your ESG risk management and ESG rating score

Environmental, social and governance (ESG) scores measure your company’s exposure to and management of financially relevant risks and opportunities. Continually developing and refining your ESG risk management with a view to enhancing your ESG score is crucial: a higher ESG rating could make your company more attractive to potential investors and support the organization in effectively managing drivers of long-term success.

ESG rating providers can give companies average, below or above-average ESG scores. For example, MSCI’s ratings are:

CCC to B – companies are termed ‘laggard’ as they are deemed trailing behind industry peers in terms of high exposure and failure to manage significant ESG risks
BB to BBB to A, termed ‘average’ – companies with a mixed or unexceptional track record of managing the most significant ESG risks and opportunities relative to their industry peers
AA to AAA – organizations foremost in their industries in managing the most significant ESG risks and opportunities, termed ‘leaders.’

The options available on your journey to becoming an ESG leader may have associated costs and there are a wide range of issues you could potentially prioritize – from climate, human rights across supply chains, to board diversity. There may also be a breadth of levers you could potentially pull to mitigate each ESG risk. The multitude of ESG choices means finding the most efficient route to improving your score may not be immediately clear.

In this insight we look at three steps to clarifying those ESG risk management decisions likely to boost your ESG score most efficiently.

Step one: Understand you ESG score and identify key improvement areas
Much like credit ratings, ESG scores or ratings are the views of third parties, such as MSCI or Sustainalytics, but are determined mostly using information your organization provides. So, on the face of it, understanding your ESG score should be the easiest step – simply get your rating from one of the ratings providers.

MSCI, for example, will provide an overall score on an industry-relative seven-point grading scale as detailed above. It will also provide ‘key issue’ scores for between two to seven factors under the environmental and social pillars, as well as a total score for the governance pillar.

Ideally, you should obtain scores from multiple data sources to make the list of risks on your ESG risk register as comprehensive as possible. The ratings can provide some high-level indications of actions likely to bolster your ESG score.

Sustainalytics, for example, highlights the frequency and transparency of your communications as key to its scores. Reviewing your internal and external communications can identify what may be driving a lower score and the opportunities for improvement. For example, was there something missing from your sustainability or corporate social responsibility (CSR) report?

However, ESG scores are only summaries of your ESG credentials that don’t go into great detail. Getting a deeper understanding of your score and how to improve it means working collaboratively with internal teams.

You may need to work with different business functions to determine the target ratings and the time frames over which you aim to achieve them. You should do this both for the overall ratings and as well as for the individual key issues, giving the teams responsible for meeting those individual targets some flexibility in how they will achieve them.

For example, risk and compliance will have a range of levers for tackling health and safety key issues, while human resources will be similarly placed to engage with human capital development or labour management; procurement may have to be on-point for supply chain labour standards.
Step two: Decide your ESG budget
In some rating providers’ methodologies ESG scores are relative. This means even maintaining your score is likely to have an associated cost. Industry relativity means your score can worsen if your peers act to improve their ESG scores and your company continues doing what it always did on ESG risk management.

In the absence of serious reputational issues, your organization might consider aiming for a gradual improvement in ratings. The costs associated with radical improvements – such as switching to sustainable aviation fuels for airlines – may appear prohibitive or logistically unfeasible.

The number of ESG risks and the levers you could pull across the range of issue could be significant, with a spectrum of costs implications. Arriving at a cost-effective path to ESG risk leadership can involve presenting a curated and costed shortlist from the complex range of choices to reach the target scores.

For example, carbon emissions is a key issue under the MSCI framework. From using cleaner energy sources, capturing greenhouse gas emissions to reducing energy consumption, there are a number of actions the business could choose to mitigate this one ESG risk with a variety of associated costs.

Focusing on those levers that are immediately actionable, such building on initiatives already under way can help boost ESG scores cost effectively.

However, to find the most cost-effective path overall means quantifying the impact of the costed ESG risk mitigation options available to the business.
Step three: Quantify your ESG Risk
Depending on the risk, you can quantify it using statistical modelling techniques, or use workshops and scenario-based techniques where you don’t have enough data available.

Ideally, quantification should result in a range of losses to capture the different scales of impact should an ESG risk be crystallized. You should consider the impact both gross and net of the ESG risk management levers you considered when you developed your ESG budget. If you plan to apply multiple ESG risk mitigation levers, analyse the impact net of all of these together.

Once you have quantified the risks individually, you can combine them to create a portfolio view. Getting a graphical perspective on the total quantified losses and the costs capturing all the combinations of the management actions can help you identify the most efficient allocations of resources, those giving the lowest overall risk for the same cost, or vice versa.

With some level of quantification and clear description of ESG risks, they can be incorporated into a designated “ESG Risk Register” for ongoing tracking and reporting purposes.

Applying risk management approaches to ESG

WTW’s recent ESG Global Risk Managers Survey showed three quarters of respondents (74%) said improving their organization’s ESG score is a core focus for their businesses. At the same time, only 17% have documented targets with clear milestones for ESG risks.

Perhaps the very first step for some organizations on improving their ESG score is embracing ESG as a risk issue. This allows risk professionals to lead the ESG agenda, applying the same risk management approaches you’ll already be using to manage other areas of risk and opportunity to ESG. The steps listed above will provide you with a relatively simple framework to help develop a sound ESG strategy and actions to achieve this. It can also create useful ESG analytics and reports for the board, the rest of the company, as well as external stakeholders including insurers and investors.

For specialist expert consulting support to identify efficient paths to boosting your ESG score, please contact us.

Disclosure

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