ESG Ratings and MSCI/Sustainalytics Methodologies

ESG (Environmental, Social, Governance) is an investment approach that takes into account non-financial sustainable development factors. The ESG assets market exceeded $35 trillion in 2023 and continues to grow.

What ESG Measures

Environmental (E)

CO₂ emissions and carbon footprint (Scope 1, 2, 3)
Water and energy consumption
Waste management
Biodiversity
Physical climate risks

Social (S)

Working conditions (safety, wages, rights)
Diversity and inclusion (D&I)
Engagement with communities
Product safety
Data protection and privacy

Governance (G)

Board of directors structure
Management compensation
Shareholder rights protection
Anti-corruption policies
Transparency and information disclosure

Major ESG Rating Providers

MSCI ESG Ratings

Methodology:

Rating from CCC (worst) to AAA (best) — 7 levels
Assesses material ESG risks and their management (not absolute indicators)
Industry approach: different factor weights depending on the industry
1000+ analysts, coverage of 8500+ companies

Key MSCI Features:

Relative approach: the company is evaluated relative to industry peers
Industry-specific material issues: for oil companies — emissions, for banks — lending policies
Momentum: trend is taken into account (improvement or deterioration)

Sustainalytics (Morningstar)

ESG Risk Rating: from 0 (best) to 100 (worst).

Methodology:

Absolute approach: assesses the absolute level of ESG risk
Two components: 1) Exposure (how much the business is exposed to ESG risks) 2) Management (how the company manages risks)
Controversies assessment: considers scandals and incidents (Volkswagen emissions, BP oil spill)

ISS (Institutional Shareholder Services)

Focuses on Corporate Governance. Traditionally used by institutional investors for voting decisions at AGM.

Quality Score: 1 (best) — 10 (worst) across four factors: Board, Audit, Shareholder Rights, Compensation.

Bloomberg ESG Disclosure Score

Philosophy differs: measures not the quality of ESG management, but the completeness of ESG information disclosure. A company that fully discloses data (even negative) → receives a high score.

Problems with ESG Ratings

Low correlation between providers: MIT Sloan study: the correlation between MSCI and Sustainalytics ratings is 0.61 (by comparison: correlation between Moody's and S&P credit ratings is 0.99). The same company can be an "ESG leader" at MSCI and "high risk" at Sustainalytics.

Reasons for discrepancies:

Different factor weights
Different data sources (the company discloses differently)
Subjectivity in interpretation
Different approaches (relative vs. absolute)

Greenwashing risk: Companies can manipulate disclosure, improving ratings without real changes. Regulators (EU, SEC) are strengthening verification requirements.

Integration of ESG into the FO Investment Process

Strategies:

ESG Exclusion (Negative Screening): Excluding sectors (fossil fuels, weapons, tobacco, gambling). The simplest approach.
ESG Integration: Taking ESG factors into account as an additional risk factor in analysis, no exclusion.
ESG Best-in-class: Selecting the best companies in ESG within each sector (including oil companies, if they are the best in ESG in their class).
Thematic ESG: Investments in themes: climate solutions, renewable energy, sustainable food, water.
Impact Investing: Measurable positive impact + financial return.