ESG RATINGS - INTERNATIONAL
PRACTICE AND APPLICATION IN
UKRAINE
Igor YAREMKO
Sc.D., Professor
Lviv Polytechnic National University, Ukraine
ihor.y.yaremko@lpnu.ua
Olena TYVONCHUK
Ph.D., Associated Professor
Lviv Polytechnic National University, Ukraine
olena.i.tyvonchuk@lpnu.ua
Abstract
The article investigates ESG ratings and their role in modern
economic conditions. The importance of ESG ratings as tools for information
support of sustainable development, their impact on the activities of
companies, ESG ratings’ problems and limitations are revealed. The
necessity of implementation of ESG rating international practice in Ukraine
is substantiated.
Key words: ESG ratings, ESG rating agencies, sustainability.
JEL Classification: G11, G24,G32, M14.
Introduction
The growing public interest in environmental and social issues,
development and wide recognition of socially responsible investment has led
to the need of investors and other stakeholders for information on the
effectiveness of company sustainable development. Today, most institutional
investors to some extent take into account environmental, social and
governance (ESG) factors. There is a growing acknowledgement that these
factors have real value and could provide better result of investments – not in
every case, but sufficiently for the significant change of investors’ approach
(MacMahon, 2020). For 2020 the total amount of assets under management
of investors that follow responsible investment strategy and integrate ESG
criteria into their decision-making process have exceeded 100 trillion dollars
USA (PRI, 2021).
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Today we are witnessing a vast increase in ESG information usage and,
as a result, the growing number of various ESG data providers (Moody's,
Bloomberg, Thomson Reuters, etc.) and rating agencies (e.g. Sustainalytics,
MSCI ESG Research, CDP, ISS) that assess companies by ESG criteria.
SustainAbility defines ESG ratings as the company’s evaluation based on a
comparative assessment of the quality, standard or performance on ESG
issues (SustainAbility, 2020, p.11). They represent independent estimation,
substantiated judgment about the companies’ sustainable performance; allow
to assess the exposure to and the level of management of material ESG risks
and potential opportunities. The raters apply special methodologies for the
transformation of large amounts of data into estimates - rating scores that can
be used in management decision-making. By providing aggregate,
systematic, and comparative data, ratings eliminate information asymmetries
and help stakeholders understand, evaluate, and manage the increasingly
complex and multifaceted nature of sustainability (Cappucci, 2018). Ratings
increase if companies begin to consider sustainability issues in new, more
efficient ways, or if some ESG-related problems arise that may indicate
management gaps. Thus, ESG ratings of Facebook have decreased due to
growing public concern about how the company deals with data security and
privacy. In the same way, Amazon's assessment by ESG ratings has declined
due to growing antitrust control and concerns about the working conditions of
its employees. ESG ratings are determined on the basis of data obtained from
different sources. First of all, that is information reported by the companies.
It includes corporate disclosures consistent with ESG reporting frameworks,
such as GRI, TCFD, CDP, SASB, IIRF; corporate governance disclosures
(governance data presented in annual reports, proxy filings, annual meeting
vote results); unstandardized information reported without the usage of any
external frameworks or guidelines that differs considerably among
companies. According to the MSCI methodology of ESG rating construction
(MSCI, 2021), self-reported data represent about 50 % of the whole scope of
the required information.
Besides asset managers, asset owners, banks, pension funds,
insurance companies and other institutional investors, an important target
audience for ESG ratings are rated companies. ESG ratings can be an effective
tool of internal benchmarking analyses for company management. External
expert analysis of ESG factors ensures an independent view on performance
48
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and the possibility to compare it with peers. This can be a powerful incentive
to plan and implement measures to improve the efficiency of companies’
sustainable development. It is believed that companies highly rated by the
ESG criteria, with good rating scores and their positive dynamics, could better
anticipate future risks and opportunities, are focused on strategic thinking and
creating value in the long run (SustainAbility, 2020).
As Veenstra and Ellemers (2020) states, ESG rating agencies play an
increasing role in “guiding businesses towards a sustainable future”. Many
researchers argue the positive impact of ratings (Shvarts et al., 2018), their
contribution to companies’ sustainable development. Meanwhile, the findings
of Clementino E. and Perkins R. (2020) show that the reaction of company
managers hinges on tangible benefits from adjusting to ESG ratings and
improving the rating scores. Analyzing the companies’ responses to ESG
ratings, researchers propose a fourfold typology: “passive conformity”,
“active conformity”, “passive resistance”, “active resistance”. It has been
grounded that more commercial than ethical considerationі determine
whether the companies would conform to, or resist the potential influence of
ESG ratings. At the same time firms, included in the “active conformity” type,
point out that ESG ratings activate different mechanisms fostering enhanced
reporting, internal organizational change, setting incentives, raise awareness,
learning, benchmarking and policy implementation (Clementino & Perkins,
2020).
Alongside the substantial value of ESG ratings as an important tool
for assessing companies’ sustainability performance researchers point out
their significant deficiencies (e.g. Diez-Canamero et al, 2020; Fowler &
Hope, 2007). It should be noted that the objective assessment of ESG factors
is associated with considerable difficulties, which sometimes leads to
significant deviations in the rating results of the same company by different
rating agencies. This is due, in particular, to the lack of uniform requirements
and standards for the disclosure of non-financial information, the difficulty of
determining many environmental and social indicators. The data analyzed by
the developers of ESG ratings are less structured, insufficiently complete and
reliable compared to the financial data provided by companies in accordance
with international or national financial reporting standards and which are
subject to external audit by auditors. Windolph (2011, p.66) has summarized
the common inherent problems of ESG ratings and outlined the following:
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1. Lack of standardization. Diversity of approaches and results, no
evaluation of approaches, no comparability;
2. Lack of transparency. Rarely full disclosure of methodology,
criteria, threshold values, etc.;
3. Bias. Emphasis on economic, environmental, or social dimension;
focus on investors’ needs; focus on larger companies;
4. Tradeoffs. Aim at single score, possible compensation of
unsatisfactory partial results;
5. Lack of credibility of information. Companies can influence rating
results, missing information verification;
6. Lack of independence. Relation between rating organizations and
companies.
The important problem of ESG ratings is also their abundance. More
than a hundred organizations around the world compile, maintain and publish
over 600 diverse ESG ratings nowadays (SustainAbility, 2020). In the opinion
of Diez-Canamero et al. (2020), ESG ratings, rankings and indexes
“constitute a chaotic universe, with instruments of different nature” that
necessitates their categorization (Table 1).
Attributes
Scope
Sector focus
ESG topic focus
Information used
Methodology
transparency
Approach for
assessing
Scale
Table 1. ESG rating typology
Types of ESG ratings
Global ratings
Regional ratings
Sector-specific ratings
Multi-sectorial ratings
Specific ESG topic ratings
Integral ratings
Ratings based on non-financial information
Ratings based on non-financial and financial
information
Ratings with transparent methodology
Ratings with non-transparent methodology
Ratings with best in class approach
Ratings with single measurement unit
Ratings with a letter scale
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Attributes
Types of ESG ratings
Ratings with a numerical scale
Source: developed by the authors on the base of (Tyvonchuk, 2020)
According to the scope - level of coverage of the companies being
evaluated, there are global (S&P Global ESG Scores, Sustainalytics’ ESG
Risk Ratings) and regional (Sustainable Ukraine ESG ratings). Rating
agencies produce multi-sectorial ratings (FTSE Russell’s ESG Ratings) and
sector-specific ones (Sustainalytics’ industry and peer ESG scores). Ratings
can be different in their specialization - agencies present thematic, specialized
ESG ratings related to a particular aspect of sustainable development (E, S or
G) and general (integral). Thus, CDP presents specialized (thematic) climate
ratings and focuses on E (Environmental) pillar. Ratings could be also
categorizing depending on the type of information used. There are ratings
based only on non-financial information and ratings that use both financial
(economic) and non-financial data to assess the effectiveness of a company's
sustainable development and its ability to create value in the long run.
Each data provider or rating agency uses its own, more or less
transparent methodology for ESG factors analysis and present the evaluation
results with a rating scale. Usually, as in credit ratings, a letter scale is used.
For example, scale from "AAA" to "CCC" (MSCI ESG Research); from від
А+ to D- (Institutional Shareholder Services Inc.), but the numerical format
of scale can also be applied. Thus, the scale from 0 to 100 is used by S&P
Global, Sustainalytics, EcoVadis and Bloomberg; the 0-5 scale is used by
FTSE International Limited.
In Ukraine, interest in ESG ratings remains at a low level. At the same
time, the pressure of national and foreign regulators, investors, creditors,
buyers and other stakeholders force domestic companies, especially those that
export their products or raise financial resources on foreign markets, to
disclose ESG issues in relevant non-financial reports and increase their
interest for being rated by ESG rating and analytical agencies. Thus, in 2020
Sustainalytics conducted a comprehensive assessment of the effectiveness of
activities in the fields of ecology, social policy and corporate governance and
assigned corresponding ratings of ESG risks to such companies as Metinvest,
DTEK, Ferrexpo Plc, Astarta, MHP, Kernel. Information on obtaining ESC
ratings from MSCI was published by Kernel and Ferrexpo Plc.
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The first ESG ratings Sustainable Ukraine were presented in 2019.
The ratings assess sustainable development and transparency of the 50 largest
(in terms of taxes paid) companies of Ukraine in 4 spheres for analysis:
financial and economic, social, environmental and corporate governance.
These spheres, in turn, are divided into areas (from 3 to 8), characterized by
relevant indicators. For example, the social sphere includes such areas as
labor relations, health and safety, personnel management and development,
human rights, local communities, marketing and labeling, privacy policy.
Each area has a different weight in integral indicator of the company
depending on the industry to which it belongs. Evaluation is held on the base
of a questionnaire with more than 100 indicators filled out by rated companies
and analysis of media and stakeholders. In the result of company assessment
the corporate sustainability ratings, sectoral corporate sustainability subratings and transparency ratings of companies in the field of sustainable
development are produced. Besides that, leaders of the best positive dynamics
of change in indicators, significant issues, and significant areas, as well as
sustainable development vector for Ukraine and Ukraine’s business
environment are defined (Sustainable Ukraine, 2020).
Conclusions
General recognition of sustainable development doctrine, increasing
efforts that companies contribute to the achievement of the UN Sustainable
Development Goals cause the urgent need for the relevant assessment of
companies’ impact on the environment and society. One of the effective tools
for external evaluation of sustainability performance, companies’ exposure to
and management of material ESG risks are ESG ratings. ESG rating agencies
play a constantly growing role in financial markets and have become
important actors on the sustainability map. At the same time, existing ESG
ratings have serious shortcomings and limitations, among which the lack of
standardization and comparability, independence, transparency of
methodology, bias, tradeoffs and low credibility of input information are the
most essential. The abundant quantity of ESG rating agencies and their
different ratings lead to the perplexity of investors and “rating fatigue” of
companies. Investigation of international practice and comparative analysis
of ESG ratings has enabled to arrange them according to such attributes as
52
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scope, sector focus, ESG topic focus, input information used, methodology
transparency, approach for assessing and scale.
In Ukraine, the first national ESG ratings appeared in 2019. Only a
few Ukrainian companies, mostly with headquarters in European countries,
exporting their products or raising financial resources on foreign markets are
rated by international rating agencies. Representation of Ukrainian companies
in international and national ESG ratings would have a positive impact on
business activity and reputation, provide the access to sustainable debt and
equity financing.
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