Ed. note: Due to my travel, ESG In the News will be delayed until tomorrow.
In an already overcrowded shopping mall of ESG ratings frameworks, ISS has launched yet another – this one explicitly adds “F” for financial. According to ISS:
Investors routinely consider both the ESG quality (i.e., the quality of a company’s management approach to environmental, social and governance (ESG) risks and opportunities) and the Financial quality (i.e., a company’s risk-adjusted profitability) of a firm in their day-to-day investment due diligence. Up until now the two have been looked at somewhat in isolation, however. Marrying the financial ‘F’ pillar with ESG performance can help create a more holistic approach to investing…
The ESGF Rating provides additional insight into companies’ financial quality as viewed through the ISS EVA lens alongside their assessed ESG performance. It thereby serves as a data point that helps determine which companies have both strong levels of risk-adjusted profitability as well as a positive ESG profile…
Data and research from the ISS ESG Corporate Rating and the ISS Economic Value Added (EVA) framework are leveraged to calculate the ESGF Rating. The overall assessment, as well as all underlying data points, are graded on a twelve-point scale from A+ (very good performance) to D- (poor performance). The letter grades correspond to numeric scores ranging from 1.0 (D-) to 4.0 (A+) in 0.25 increments.
I’ll admit it – I’m a bit confused. Hasn’t the point of the ESG movement been about financial materiality of ESG? As Liz said, “I thought the F has been implied.” On the other hand, maybe there are audiences needing a helping hand in seeing the connection. After all, inconsistency of ESG reporting/metrics and lack of third party validation have been something of a challenge.
New Way to Conduct Materiality Assessments
So let’s play ball with this idea for today’s blog (at least a game of holiday backyard family football but without the crazy uncle who takes it too seriously). For now, let’s ignore the EVA-specific aspect of ISS ESGF – how might a company try to both separate and link ESG to financial materiality at a practical level? I thought back to my time conducting environmental risk assessments and validating risk values and linkages and an idea formed.
A company could start by conducting a traditional financial materiality assessment of its business and operations – ignoring ESG for this part. Just consider basic business factors through a strict 10-K or operational lens. You might even want to exclude your ESG team from this step to help “sanitize” it as much as possible. Then flip things around – conduct a second stand alone materiality assessment focused on ESG, excluding “the business” from the process. Now you have two separate materiality assessments with some connections, but there will still be gaps.
Here is the fun part – bring the teams together and connect the two assessments like puzzle pieces. You may find it useful to mirror risk interconnections mapping concepts the World Economic Forum does for their annual Global Risk Reports. Here is an example extracted by OliverWyman from WEF’s 2020 report. Granted, this is risk-focused and doesn’t provide opportunities directly, but it isn’t a big leap to go from risk to opportunities. It also may not directly address capital deployment effectiveness (which is what EVA is about). But it offers more clarity about linkages between ESG and financial materiality in a practical way that can be communicated to investors, raters, etc. It may also help management and operations visualize linkages for program development, implementation, monitoring and on-going reporting.
One might argue this is not the most efficient way to do this. I think most companies attempt to get this result from a single activity/effort. But based on my experiences conducting enterprise environmental risk assessments – and separately validating them outside of the conference room – there is value in breaking up the process and then connecting the pieces.
I am interested in hearing your views and experiences on this. Drop me a note at firstname.lastname@example.org.