Eco-Responsible Investments: Rating Agencies

by Clint Cox

The essential

  • Social and environmental rating agencies evaluate companies according to environmental, social and governance (ESG) criteria;
  • There are many rating agencies, sometimes specialized on one of these three criteria;
  • These agencies have methodologies of their own, but the trend is towards the homogenization of practices.

The social and environmental rating agency, or extra-financial rating agency, is tasked with assessing companies according to environmental, social and governance (ESG) criteria. Unlike the conventional financial rating agency, it is not remunerated by companies but by investors and managers directly, who seek to reinforce their investment decisions. However, a company may also request an assessment from an extra-financial rating agency in order to highlight its responsible positioning.

The resulting rating is used by asset management companies to build and market socially responsible investment funds (SRIs).

The ESG criteria on which the extra-financial rating is based

Social and environmental rating agencies do not assess a company’s ability to repay debt, as traditional rating agencies do. Their mission is to measure the company’s potential to create sustainable value. For this, they integrate three criteria:

  • The environmental criterion : it measures all the initiatives taken by the company to limit its environmental impact and to make the transition towards the use of renewable energies.
  • The social criterion : it studies the social climate within the company. It is about respect for diversity, human rights, and the evaluation of working conditions.
  • The governance criterion : it focuses mainly on transparency around executive compensation, the organization of powers, the rights of minority shareholders, etc.

As a result, the extra-financial evaluation is longer-term than the traditional financial evaluation. She studies internal business transformation processes rather than managing her debt.

The different social and environmental rating agencies

Most social and environmental rating agencies appeared in the early 2000s. In France, the main non-financial rating agencies are: Vigeo , Ethifinance , Innovest and BMJ CoreRating. Some specialize in the evaluation of one criterion to the detriment of others. Proxinvest, for example, works exclusively on governance issues.

In view of investors’ growing interest in socially responsible investments, the traditional players in financial rating have decided to take into account these extra-financial criteria in their approach. Thus, Standard & Poor , which bought the British Trucost in 2016 (rating agency specialized in the study of the environmental impact) integrates the delay in sustainable development policies among the risks likely to affect in the longer term the financial health of the company.

It should also be noted that a growing number of management companies and some large institutional investors (pension funds, insurers) are developing their own rating system.

The methodology of SRI rating agencies

The methodology of SRI rating agencies

There is no standard methodology for performing the scoring. Thus, the agencies develop their own indicators, from a selection of inputs. However, the process of obtaining these inputs rarely differs: agencies consult public documents, develop dedicated questionnaires which are then distributed to employees and contractors of the company, rely on stakeholders (NGOs, unions, organizations government, etc.) and the media.

In addition, it organizes meetings with employees and management, which aim to determine:

  • prevention measures taken by the company to limit crises related to ESG issues,
  • the level of application of international standards and ESG best practices ,
  • the quantitative and qualitative performance of the initiatives taken by the company (example: the carbon footprint).

The majority of rating agencies exclude from their analysis companies that are in controversial industries such as tobacco, alcohol, gambling, prostitution, armaments, or those that practice child labor. These exclusions may however differ depending on the country of origin of the agency

A desire to standardize eco-responsible rating methods

A desire to standardize eco-responsible rating methods

What is more subjective than the appreciation of a socially responsible approach? Unlike exclusively financial, strictly quantifiable criteria, a dimension such as the level of transparency of a company is difficult to measure with indicators. It is therefore not surprising that a score of the same company varies according to the agency that established it, especially since all do not allocate the same weighting to each of the criteria.

However, common indicators are beginning to be deployed: the carbon footprint, for example, is a measure that serves as a basis for rating agencies to assess the environmental impact of the business. The Sustainable Development Goals (SDGs), initiated in 2015 by the United Nations, are gradually integrated into the methodology as benchmarks for impact measurement.

Although the trend has been towards the centralization of the social and environmental rating players in recent years, it does not provide any guarantee that the results will be interoperable. In its action plan on sustainable finance, the European Commission wants to “study the appropriateness of amending the regulation on credit rating agencies that would require them to explicitly include sustainability factors in their assessments” . In this sense, a survey on the quality of research and the independence of rating agencies is planned for the year 2019.

What Nalo does for you

Despite their interest in sustainable savings, only 3% of French people have been offered SRI investments in 2017. There is still little offer to invest in socially responsible funds. Even where possible, it is sometimes difficult for the non-expert investor to select from the multitude of funds offered.

Nalo offers a life insurance policy in delegated and tailor-made management, which allows you to easily opt for eco-responsible portfolios. You benefit from the expertise of a FinTech in the selection of ETFs that meet the ESG criteria while taking advantage of their performance at reduced costs.