How To Operationalize ESG

  • MAY 8, 2020
  • //
  • ESG

Every public board is now sensitized to the critical priority of ESG and in the process of figuring out how to operationalize ESG.

There are two parts of how you measure ESG in terms of decisions that management needs to make and that the board needs to oversee in an ongoing set of external communications and what you will measure and report.

The first decision is to select a ratings agency. For example, the leading ratings agency appears to be MSCI having emerged as the most popular and widely deployed rating agency for large scale Fortune 500 companies. Alternatives to the MSCI ratings agency is their competitors: Sustainalytics and ISS.

The second part of creating a measurement system for ESG are the frameworks that actually identify the specific elements that your company is going to measure and report out on. The two most popular and widely deployed frameworks are SASB or GRI.

Nasdaq has done an assessment and their data shows that the two most influential and widely adopted choices of a rating agency combined with a framework appear to be the combination of MSCI rating agency and SASB framework.

  • Between 2014 and 2019, the median daily price return for the MSCI “Laggards” was 4.8 bps, which is nearly 23% less than the S&P 500 over the same time frame
  • During the same time frame, MSCI “Leaders” displayed a 6.8% higher median daily return relative to the S&P 500
  • MSCI Leaders displayed noticeably less volatility (152 bps daily volatility) than the S&P 500 market, along with higher forward-looking trading multiples, greater profitability, less short interest and greater access to free cash

There is a new framework which is emerging from State Street Global Advisors which is called the “R Model”. This is a risk management tool that takes the data points on the specific quantifiable elements that the company is going to measure. The purpose of SSGAs R Model framework is to help companies quantify ESG Data and give a score on the data.

Some examples of the specific items that a framework measures would include things like executive compensation, human capital statistics (such as involuntary departures), environmental practices, safety statistics.

SASB tracks and encompasses the capital market of large cap public companies. Stock exchanges for example Nasdaq is aligned with using the SASB standards and offers ESG assessments for companies helping them quantify and create/operationalize a framework based on a combination of SASB and MSCI seems to have a very positive pricing impact and influence on company stocks.

As a first step, your board you may want to ask management to look up and report to the board your companies’ MSCI ratings to see if you are getting the correct amount of credit that you should for things you may already be doing.

Today each company in the S&P 500 has an MSCI rating. There may be many positive things your company is doing, and you are not getting credit for them. Perhaps you are not disclosing many of your standard and very positive HR best practices. Likely you have diversity and inclusion programs and anti-harassment trainings. Likely you track your retention of talent. You may also have health and wellness programs as well as measuring safety and injury rates based on your company’s industry. Another area where you likely have good policy but may not be reporting them is on cyber and info security oversight programs. Many boards are now using the NIST frameworks for measuring the ~22 items that your CIO or CISO assesses and shares with the board.

My recommendation for boards is to consider requesting management share a read out in the next couple of quarters on the company’s current rating agency from either MSCI or MSCIs competitors ISS or Sustainalytics. You may also want to consider asking management to select a framework to measure and report out on many of the positive things you are likely already doing frameworks you could ask management to review and recommend might be either SASB, GRI or alternatively the new State Street R Model.

ESG is here to stay. Every company is going to need to explain how they are measuring and communicating to a full range of constituencies son ESG. Clearly investors now care. Customers, employees and other stakeholders care as well.

I suggest boards figure out where ESG should fit in a committee framework, for example gov nom or compensation. Investors are already beginning to ask where ESG reports i.e. directly to the board, to internal audit, CFO, GC and if ESG performance is in anyway connected to the leaderships team compensation. I believe these emerging trends are going to speed up not slow down and I believe your company will be rewarded for its leadership if you get in front of the ESG trend.

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