This year, ESG ratings have been gaining momentum, as investors, shareholders, consumers and companies in general increasingly prioritise sustainable practices in their decision-making processes. International certifications have always been there. While ESG ratings prominently entail the analysis of sustainability standards, certifications foresee an audit process of international standardised norms. That’s why their function is different. And they ought not to be confused. So, we take the shoes of an ESG Ratings analyst to explain why ESG ratings and certifications aren’t the same thing.
One of the primary reasons ESG ratings vary from certifications is that ratings are inherently opinions. [1] Rating agencies assess companies based on a variety of criteria that can differ significantly from one agency to another. These criteria involve both subjective and objective judgments about what constitutes excellent or faulty ESG performance. With no surprise, two different ESG rating analysts may arrive at vastly different conclusions regarding the same company’s ESG rating grade [2]. In the case of certifications, this simply doesn’t happen.
Impartiality does play a crucial role. The independence of ESG ratings adds to their value [3]. Unlike certifications, which can be influenced by stakeholders and entities they aim to evaluate, ESG ratings are designed to be impartial assessments of a company’s ESG performance. This independence ensures that the ratings are not swayed by stakeholders [4]. As in the case of certifications, stakeholders preferences cannot jeopardise the integrity of a rating process. That’s why every rating agency should have strong governance mechanisms ensuring an adequate treatment of conflicts of interest.
Moreover, if a rating agency serves one or more investors, then its best interest would entail a taylor-made assessment. If a rating agency serves the client-company, its independence is much more higher. And the process has a complete different nature. So, until law will define univocally ESG ratings, something still in the making in the EU Single Market, variability could furtherly highlight that ratings are not definitive indicators of a company’s performance but rather interpretations shaped by the rating agency’s methodology, expertise and criteria.
The main dilemma of certifications is their lack of dynamicity. Environmental, social and governance guidelines provided by the UN, OECD and the EU on sustainability are continuously evolving [5], and what may be deemed acceptable today could change tomorrow, as it happened with the inclusion of gas in the EU Taxonomy. ESG ratings reflect these shifts by incorporating new guidelines, information and trends, allowing for a more adaptable approach to sustainability assessment. Certifications, on the other hand, often require a company to meet specific criteria at a single point in time, which may not accurately represent ongoing efforts or improvements. By nature, certifications cannot be forward-looking, as ESG ratings are deemed to be [6].
Certifications and ratings do share a common future: while certifications are already regulated, ESG ratings will be so in a few months. At least in Europe, where the European Commission is supposedly delivering the final text of the ESG Ratings Regulation “ESGR” by the end of 2024. However, while some ESG ratings could be sector-agnostic, certifications are topic-based. While, most of times, ratings entail certifications in their evaluation criteria, certifications don’t. Whenever a company obtains a certification, it gives the ESG rating analyst the idea that it is working strategically on that topic. But then the analyst can delve into the company’s initiatives and strategies. Certifications do not include ESG ratings but rather quality management, health and safety and cybersecurity, just to mention a few. An analyst-driven rating process can well perceive the attention given by the company to these topics altogether. Certifications – on the other hand, can pinpoint the commitment of the company to a specific topic but not the full picture on the company’s ESG strategy. Of course, regulation will give ESG ratings the standing they deserve. Once legally covered, they will serve as a holistic measurement of a company’s sustainable grade. Very similar to what the market has been qualifying for credit ratings: an independent, scientific and neutral measure of risk.
In conclusion, while both ESG ratings and certifications are valuable for assessing sustainability, their goals are different. By accepting to obtain a certification, companies do commit to endorse a specific path verified regularly by an independent auditor or reviewer. By relying on independent ratings, companies accept to commit to measure where they sit compared to international ESG standards. In brief, ESG ratings and certification processes do not exclude themselves. But understanding their difference will be more and more crucial.
Articolo di Manfredi Morello
Sources:
[1] European Commission COM/2023/314 final - Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities.
[2] Berg F., Kolbel J., and Rigobon R. “Aggregate Confusion: The Divergence of ESG Ratings”. URL: https://deliverypdf.ssrn.com/delivery.php?ID=255100081087114095124127119010000023016039060039010087100112103070068088029100065022019117103061008030027118125028097097093075043075078051054004005104026101090114105003079016086015090028103018123087000115006004097079076012068100093125102087123082003027&EXT=pdf&INDEX=TRUE
[3] Dr Daniel Cash “Can Regulatory Intervention Save the Sustainability Rating Industry?”. pre-publication version of an accepted paper, to be published within the Business Law Review. URL: https://publications.aston.ac.uk/id/eprint/42139/1/SSRN_id3688905.pdf
[4] Parguel B. Benoît-Moreau F. and Larceneux F. “How Sustainability Ratings Might Deter “Greenwashing”: A Closer Look at Ethical Corporate Communication”. June 2008. Journal of Business Ethics Vol. 102 (1). DOI:10.1007/s10551-011-0901-2.
[5] Morello M. (2024) 20 años en el camino de la Sostenibilidad: del nacimiento de la calificación ESG a su regulación. Diario Responsable. URL: https://diarioresponsable.com/opinion/36497-20-anos-en-el-camino-de-la-sostenibilidad-del-nacimiento-de-la-calificacion-esg-a-su-regulacion
[6] European Commission (2023) “Executive Summary of the Impact Assessment Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on the transparency and integrity of Environmental, Social and Governance (ESG) rating activities”. URL: https://ec.europa.eu/finance/docs/law/230613-summary-impact-assessment_en.pdf
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