Our thinking

What’s in a rating

7 January, 2022

Over the past few years, ESG investing (that is, investing in companies seen to be taking action on environmental and social issues) has taken off. The notion that investors can make money while financing companies which create a better world is an appealing one, as evidenced by the record amount of capital directed towards ESG funds in 2021. 

For this concept to hold true, it’s essential that the systems in place to recognise companies with a positive ESG impact are accurate, meaningful, and well understood by investors. This not only ensures that companies working hard to improve their ESG performance receive due recognition, but also means that those looking to direct their capital to sustainable businesses have a roadmap for doing so.  

Today, many ESG investment decisions are guided by an ESG rating system developed by investment research firm MSCI. But a recent Bloomberg analysis of the methodology used by for the ratings has highlighted several key issues with the system. Chief among these is that the ratings do not actually assess companies’ ESG impacts on the world, but rather the degree to which ESG issues present an area of risk for a company’s bottom line. What’s more, increases to companies’ ratings are often determined simply by changes to the rating methodology or relative performance within an industry, rather than any actual improvements by a company itself.  

MSCI themselves are candid about the fact that their ratings are designed to look at the financial significance of ESG issues, and this in itself is helpful and important. But the massive rise of ESG investing will only create positive change if it rewards companies that are actually doing good, rather than managing risk or filling in forms well. Creating a system which does so will not be easy, but if MSCI won’t, then someone else must. 

Our rating? MSCI must do better.

By Louise Podmore