Focus on ESG Data, Labels and Ratings – Insights of the Frankfurt School of Finance Programme Certified Expert in Sustainable Finance

Part four of learning by Esther Meyer, Fondation de Luxembourg

Since my last report it was quite busy with the finalization of the two units about ESG data and ESG ratings and labels and on top an assignment to be completed before end of June. You might ask yourself what such an assignment is about and I will give you some insight today.

But let me start with ESG data, labels and ratings. Starting point is the definition “ESG data provide information on companies´ performance in terms of environmental, social and governance factors, while ESG criteria is a set of standards for a company´s operations that ESG conscious investors use to screen potential investments.” Next to the companies, ESG data are used as well by financial research analysts, banks and other lenders, investors and the public sector. According to a survey among ESG data users the main reasons for the usage of the data are the management of investment risks, investors´ demand and ESG performance as management quality indicator. ESG data were sourced from the companies, public databases, media and NGO´s. In the following section the integration of ESG KPI´s is discussed and the most important standards and approaches are described and compared. Probably the best known one are the 17 UN Sustainable Development Goals (SDGs).

Hereafter the main data providers (e.g. MSCI, Morningstar-Sustainalytics and VigeoEiris/ imug) and their approaches are presented and it is highlighted that the lack of disclosure of the evaluation process is a common deficiency of all the providers.

ESG ratings should help investors to identify the companies´ ESG responsible behavior and make this transparent in a simplified way. The usage of ratings has already a long tradition and the focus on socially responsible investments is gaining strengths at least since the 1990^th. In this context the differences between credit ratings and ESG ratings are explained. ESG Rating providers collect their data from different data sources (companies, media, ESG data providers). Four dimensions are defined for the categorization of ESG ratings (coverage, scope, data sources and methodology). The different categories are explained to the students and a comparison between the main providers was made.

There are several limitations and challenges while using ESG ratings. The main critics are:

• The data are reported by the companies
• The data are historical and not forward looking
• The frequency of update of the data points
• The lack of transparency in the calculation
• Potential limitation to a subset of ESG data (e.g. focus on environmental aspects).

Overall it is highlighted that for the future more disclosure, more specification and more customer design is needed. While ESG ratings are mainly used by institutional investors, ESG labels might become an interesting alternative for non-professional investors to help to identify financial products fulfilling the sustainability criteria. It was nice to see that the LuxFlag ESG Label is as well mentioned in the script.

The main advantages of labelling are the reduction of information costs for non-professional investors, the harmonization of SRI quality standards and the avoidance of green washing.

While highlighting the advantages, it needs to be mentioned that the provided information shows the fulfillment of minimum criteria, but is not an alternative for an in-depth analysis.

Coming now to the assignment. From May 20^th to June 30^th, 2021 we had time to work on it. During the assignment, response to overall 22 questions (a mixture of multiple choice and open questions) had to be completed. In addition to the use of what has been learned during the course quite a lot of research work and personal reflection was required to answer the questions. The case studies were set-up in a way that the student had to look into different cases from different perspectives (e.g. an employee of a bank, a private investor). The range of topics covered was broad from e.g. a reflection of regulatory rules, the assessment of impact investment cases to the analysis of an ESG company reporting.

To summarize it from a personal perspective: It was a very useful and educational experience, filling this already interesting topic with life. In case you might decide to register for the Sustainable Finance Expert course, small hint on a side: Plan enough time to complete the assignment as you come across so many interesting information and material that it is difficult to stop reading and investigating.J

Now, while waiting for the results I wish you a very nice summer time and looking forward to be back after my final exam and a final report end of September. Take good care and stay healthy.

Author: Esther Meyer

Read other articles by Esther Meyer: Insights part 1, Insights part 2, Insights part 3