Head of ESG investments, Saxo Bank.
Summary: The interest for sustainability and responsible investment is growing as the world faces pressing environmental, societal and governance issues. To help clients make better informed decisions that are aligned with their values, ESG risk ratings for stocks have been added to Saxo's platforms. ESG risk ratings measure a company's exposure to material environmental, social and governance risks and how well a company manages those risks. The ratings will help you assess how sustainable your portfolio is.
ESG ratings are measures of how well a company manages material environmental, social and governance risks it is exposed to. Environmental risks (E) are associated with greenhouse gas emissions, waste management and pollution. Social risks (S) involve employees’ safety and wellbeing, as well as diversity, equity and inclusion. Governance risks (G) cover transparency, anti-corruption, business practices and the board of directors’ composition and independence.
Negligible and low categories are assigned to companies that manage their ESG risks well, whereas high and severe categories are assigned to companies that manage their ESG risks poorly. A medium rating means that some risks are managed well, while other risks are managed poorly.
ESG Risk categories are absolute, which means that a bank can be directly compared with an oil company, or any other type of company.
In addition to reviewing a company’s ESG risk rating, it is possible to screen for stocks using a specific ESG risk category. The screener will then only return the list of stocks that meet the specified criteria.
Ratings are typically based on historical data, thus they are backward-looking and shouldn’t be used to forecast return potential.
Also, as there are no standards for assessing a company’s ESG practices, providers use different methodologies, which are at times subjective and can result in major differences. Ratings correlations between the major providers are as low as 0.45 (Source Brandon, R. G., P. Krueger, and P. S. Schmidt. 2021. “ESG Rating Disagreement and Stock Returns.” Financial Analysts Journal 77), which is substantial. In comparison, the correlation between credit agencies' ratings is above 0.9 and perfect correlation is 1. This divergence makes comparison difficult, but it can also serve to highlight problem areas that should be further researched by investors.
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