Introduction

ESG ratings have a huge impact on evaluation of a company’s commitment towards sustainability. It also helps in keeping a check on the company’s ethical practices. It helps investors by evaluating the company’s overall performance and achievements across all the domains. The main focus of ESG raters is on risk rather than impact.

Why are ESG Ratings Needed

ESG ratings act as a guide for investors to make investment choices such as assisting managers and pension funds. Many better equipped and skilled investors firmly believe that companies having high ESG ratings can perform well for the long term. These ratings also help clients to produce sustainable products, recognize risks and opportunities, provide extra financial information to the finance analysts and support fund providers. Apart from investors and stakeholders, ESG ratings also matter to customers, employees and regulators. While investors are more supportive towards businesses that follow ethical and sustainable practices, employees focus on working with firms that share the same values as theirs. Regulators consider ESG ratings helps in keeping record of companies in terms of corporate governance, preservation of employees’ rights and environmental protection.

Navigation of ESG Ratings

This is the era of double materiality assessment. Double materiality goes beyond the traditional method of financial materiality which leads to decrease in financial issues of companies and increase in their impact on environment and society. Investors are also concerned about impact of ESG factors on a company’s operational performance from the point of view of financial materiality. However, double materiality helps in company’s positive impact on the environment and the society. This aspect also plays an important role in facing and reducing global challenges such as climate change, social inequality and incorrect governance. It acts as an increasing recognition in the investment community as well.

Importance of ESG Ratings

ESG ratings have become important and prominent among investors in recent times, due to its strong resonation with investors’ needs. Here are some factors that make ESG ratings extremely important for investors:

• Establishing Relationship between Companies, Environment and Society: Nowadays, businesses are asked to function in a sustainable and responsible manner by the stakeholders. This is because the public has more concern about societal concerns such as human rights, climate change, etc. Here, ESG ratings help stakeholders to analyse companies’ performance. This establishes an important relationship between companies, the environment and the society.
• Increasing Claims for Responsible Investment: Investors provide capital to the businesses having same beliefs as theirs and the ones who can achieve long-term gwowth and profit. They like to find companies that can perform well for a long period of time while managing ESG risks and grabbing opportunities created due to ESG ratings. This becomes a way to assess sustainable and ethical practices of the firm.
• Embracing ESG Ratings for Higher Returns and Lesser Risks: ESG metrics is one of the helpful tools to identify the risks along with the profits. Investors consider these metrics to evaluate risks and opportunities of the companies and also compare their performance with the peers. Profound investors are now better equipped in analysing today’s market due to incorporation of ESG considerations in their investment strategies.
• ESG Corporate Ratings Leads to Corporate Improvement: ESG ratings set a benchmark for comparison and help investors in the identification of growth and opportunities. For asset managers, ESG becomes a helping hand in listing sustainable and ethical practices to enhance company’s performance in environmental, social and governance sectors. ESG ratings also help businesses in avoiding legal and reputational issues. It helps the managers in developing healthier connections with stakeholders and clients.
• ESG Ratings Can Improve Transparency and Accountability: One of the major functions of ESG is increasing transparency and accountability in the activities of the company. This can be achieved by presenting the correct reporting framework. This accountability and transparency can help investors in making better choices regarding morality of the company. ESG ratings encourage companies to publish their data more often, which makes them more accessible for the stakeholders. Thus, companies are considered responsible for their practices and have a pressure to abide by ESG standards.
• ESG Ratings Can Promote Positive Change in the Industry: As mentioned earlier, ESG ratings encourage businesses to adopt sustainable and ethical practices but the question is how? The answer to this question is by establishing a competitive market. Due to this, firms start embracing best practices and pay more attention on solving societal and environmental problems. They also co-operate with the stakeholders which would lead to positive changes in the market and increase in a sustainable environment.

Impact of ESG Rating on Investments

ESG standards have become a valuable tool for investors due to their regular use in making investments decisions. Nowadays, investors give more priority to an ESG portfolio rather than the traditional one while analysing a company’s performance. This leads to companies integrating ESG principles in their strategies more often which increases flow of capital and improves financial performance. It is important to get a good ESG rating because if a company gets poor ratings, investors tend to exclude them considering it an unsustainable asset. If this mindset is followed by multiple investors, then the company could have a huge impact on its stock prices.

Take Away

This is the brief explanation about the importance of ESG ratings for the companies as well as the investors. The impacts of ESG ratings on a company is also stated. Please let us know through your valuable feedback and the suggestion in the drop box.