Advancing Global Sustainability: The Urgency of Harmonized ESG Ratings
There is an urgent need for globally standardized ESG measuring, reporting, and ratings to ensure consistency, comparability, and reliability across industries and regions. We require a globally harmonized, science-based, transparent framework based on a comprehensive lifecycle assessment. This methodology should be applicable to both private companies and countries.
It is definitely needed to make it imperative for CRAs to include ESG evaluation in their all ratings by legally binding requirements.
The call for global standards in ESG ratings originates from the recognition that a unified framework is essential for fostering consistency and reliability. A global standard would provide a common language for ESG reporting, ensuring that companies worldwide adhere to the same set of criteria. This standardization is not only desirable but also necessary to facilitate meaningful cross-industry and cross-border comparisons.
It is estimated that the costs of climate change and biodiversity loss for our economies are at least ten times greater than those of the Covid pandemic, leading to situations where no business is profitable or manageable. In financial risk evaluation, the principle of third materiality suggests that if you contribute to the problem of climate change and biodiversity loss, you are directly increasing your own risk and causing financial risk to the company.
The cost of non-action needs to be made visible and effective, with ESG ratings serving as the tool for this.
We have a well-rounded system in IFRS for measuring the return on investment or the debt level of a company. This logic needs to be mirrored symmetrically to ESG matters also. There is a need to establish reliable sources for data collection and a transparent methodology for calculating the CO2 footprint and other indicators. The open masterfile and calculation methodologies for information sources could be IFRS’s set of rules, the UN statistical authority, or both. The Beyond the GDP project in the UN requires anyway alignment with calculation models and data in the private sector. In the future, Copernicus and other effective data collection systems will serve as a firm data source on the environmental condition. For SMEs, a simplified version of the ESG reporting scheme, akin to a “nutritional value tablet,” is necessary, where reporting data is easy to extract and calculate.
A primary objective of global ESG standards is to produce reliable information that facilitates cross-industry and cross-sector comparisons.
Investors need a clear and standardized yardstick to assess the ESG performance of companies operating in diverse sectors. This approach allows for a more nuanced understanding of how companies within the same industry and across different sectors are faring in terms of sustainability and responsible practices.
ESG considerations are increasingly viewed as a fundamental aspect of risk management, arguably surpassing the importance of traditional financial reporting. Companies that prioritize ESG factors are better equipped to navigate a complex landscape fraught with environmental, social, and governance risks. Therefore, ESG ratings serve as a proactive measure, helping investors identify and mitigate risks that may not be immediately apparent through traditional financial metrics. This would enhance trust and stability in markets overall, attracting more capital to companies with strong ESG performance. Currently, over half of all investor portfolios are in unsustainable investments, and only about 5 percent are in sustainable investments. Reversing this trend is crucial for combating negative impacts on the planet, people, and businesses and ensuring that pension funds are invested sustainably.
Global standards would promote consistency in data collection and reporting methodologies, facilitating more accurate and reliable ESG ratings. This would enable better benchmarking and performance evaluation across industries and regions. Standardization would also help mitigate the risk of greenwashing, where companies overstate their ESG credentials.
Rating agencies play a crucial role in evaluating and rating companies based on their commitment to these diverse factors, ensuring that the assessment goes beyond financial metrics. The more complex the setting, especially when evaluating a company’s financial stability and future performance, the more there is a need for ratings as a professional tool. Investors increasingly require this kind of rating service.
The ecological competence and sustainability of companies are as important as financial competency, if not more so, from a societal perspective.
Hence, there is an obligation for CRAs to rate and align the ratings. They cannot be too separate but need to develop methodologies together.
Extending the application of ESG ratings beyond private companies to entire nations is a logical progression. We cannot demand the private sector to be sustainable if the public sector and societies are doing the opposite. Ecological competence is rising to be as important part of knowledge and knowhow as the understanding of markets, economics, and financial aspects for the politicians, financial sector, companies, and credit rating agencies. This is the only way to solve our looming sustainability crisis.
