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What’s Next For The Future of ESG Ratings?

ESG Rating meter

On the 8th August 2023, credit rating agency S&P Ratings confirmed they would no longer be publishing Environmental, Social and Governance (ESG) indicators in their credit rating reports. After two years of supporting the ESG indicator process, the agency has made the decision to return to a system of qualitative and quantitative analysis instead - becoming the third agency so far to make the change.

With ESG ratings previously being highlighted as a valuable tool in assessing a company's commitment to responsible practices, they’ve played an important role in shaping widespread investment and consumption decisions. However, as agencies like S&P begin to abandon the rating, questions are being raised about their effectiveness, and the potential for business greenwashing occurring through the final reports.

What Is The Benefit of an ESG Rating?

Put simply, ESG ratings are a quantifiable measure of a company's performance in environmental, social, and governance areas. They provide investors and stakeholders with insights into a company's sustainability practices, ethical behaviour, and corporate governance - helping to inform important decisions for the company moving forward.

In recent years, these ESG ratings have grown in popularity in a number of industries, partially due to the growing interest in sustainability as a whole. Regulatory changes and government interventions have also had an impact on the requirements for ‘green businesses’ to uphold new sustainability standards, and to disclose ESG-related information to both the public and the relevant authorities. With stakeholders demanding greater transparency and ethical practices from the businesses they invest in, ESG ratings were a useful way for companies to demonstrate their commitment to these values.

However, as ESG ratings gained prominence, so did criticisms and concerns about their effectiveness.

What Are The Challenges Facing ESG Ratings?

Whilst ESG ratings do have their advantages, one of the primary criticisms is the lack of standardisation in ESG metrics and rating methodologies, with different rating agencies using varying criteria and data sources, leading to inconsistent and sometimes contradictory ratings. As ESG ratings rely so heavily on the gathering of quality data from companies and industries, it’s easy for this data to be incomplete, inaccurate or exaggerated - through simple mistakes or intentional manipulation.

Without reliable universal methodologies in place, many companies can take advantage of the ESG rating system in order to greenwash their data - inflating or misrepresenting the sustainability of their business to increase their chances of investment. Additionally, sustainability as a whole is relatively difficult to measure over short periods of time. With so many of the sustainable measures implemented within businesses and industries requiring months or even years to show a true impact, the data collected by ESG rating systems is unlikely to highlight the real results - with companies prioritising actions that improve their immediate ratings without making meaningful, lasting changes.

So what does the future of ESG ratings look like?

ESG ratings have come a long way in helping investors and stakeholders assess a company's commitment to sustainability and ethical practices. While they face challenges related to standardisation, data quality, greenwashing, and short-term focus, it's not the end for ESG ratings.

Many reputable agencies, governing boards and credit-checking companies are still committed to monitoring ESG ratings as part of their overall analysis, and the demand for sustainable proof is still a high priority for investors around the world.

Whilst some level of standardisation, improved governance and transparency might be required to improve the process in future, it’s likely ESG ratings will continue to be a core part of business evaluations moving forward.

‘With the slow but steady movement toward standardisation of mandatory ESG disclosure and reporting requirements it is reasonable to assume that the value of ESG ratings could be on the decline, but we aren’t quite there yet. The SEC is scheduled to provide an update this fall while the EU Commission adopted the European Sustainability Reporting Standards in July (2023).’ - Jon Taylor, Executive Director, Anthesis


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