January 10, 2025
The ESG Ratings Dilemma: Why Different Rating Agencies can't Agree
The Rating Disparity Problem
One of the most striking issues with ESG ratings is the substantial variation between different rating agencies. For instance, a Swiss company might score a perfect 10 with Sustainalytics while receiving a dramatically lower score from another rating agency such as LSEG or MSCI. This lack of consistency raises serious questions about the reliability of these ratings.
Why Don't ESG Ratings Converge?
The reason for these disparities lies in the diverse business models and focus areas of different rating agencies:
- ISS (Institutional Shareholder Services): Primarily focuses on governance through proxy statements and executive compensation
- Sustainalytics and S&P: Emphasize environmental factors with a strong social mission
- LSEG and MSCI: Concentrate on shareholder value, using ESG primarily to identify investment risks
Different Methodologies, Different Results
The methodological approaches vary significantly among agencies:
The Business Reality
One expert in the video noted, "It's a money-making machine." Rating agencies have little incentive to converge on their methodologies, as their distinct approaches help maintain their unique market positions in what would otherwise become a commoditized industry.
Implications for Companies
The fragmented nature of ESG ratings presents a significant challenge for companies trying to demonstrate their sustainability credentials. While these ratings might serve marketing purposes in sustainability reports, they fall short as credible tools for communicating genuine social and environmental impact to stakeholders.
Conclusion
The current state of ESG ratings reflects a fundamental tension between different approaches to measuring corporate sustainability. Because greater standardization in methodology and purpose is not expected due to competition between the ESG raters, companies must look beyond ESG ratings for meaningful ways to assess and communicate their sustainability performance.