Towards ESG 2.0
Making ESG ratings real sustainability ratings
June 2023
Summary
The increasing popularity of sustainable finance has given rise to a new dimension of business
enterprise: ESG (Environmental, Social, Governance) data providers and raters, which play a crucial
role in sustainable investing. Demand for ESG data is rapidly increasing, and is largely driven by both
investors’ demand and new regulations setting ESG disclosure requirements for companies in the EU
and the US in particular.
At present, high ESG scores are mistakenly believed by professional and retail investors alike to be
indicators of sustainability or greenness. Well-rated companies are supposed to value and enact
practices that put environmental and climate protection, social justice and inclusivity, and
transparency in governance at the core of their business model.
However, it has been well documented over the last years that ESG scores are far from portraying a
valid picture of a company’s green credentials. Instead of ensuring that the best performing companies
get the recognition and financing they need, unregulated ESG ratings are misleading asset managers
and investors. Ultimately, their flaws have exacerbated greenwashing on financial markets.
This is all the more visible in the transport sector, where large polluting companies with too slow
decarbonisation pathways, for instance carmakers, aircraft manufacturers or shipping companies,
obtain remarkably and disturbingly high ratings. A major problem is that ESG scores are heavily
focused on the assessment of the financial impact of sustainability risks for the corporation (outside-in
materiality), and don’t take into account the impact the corporation has on nature and people which is
relevant for wider financial stability risks and for policy objectives outside the field of finance.
In this context, it is essential to overhaul the current system of ESG ratings and regulate this growing
market in Europe, starting from ensuring consistency between ratings and establishing regulatory
frameworks for the usability and impact of ESG data.
A briefing by
1

The objectives of this position paper are both to address the inconsistency in ESG ratings and to
propose recommendations to improve the European Commission’s proposal “on the transparency and
integrity of Environmental, Social and Governance (ESG) rating activities” published on 13th June 2023.
We recommend a more profound transformation of the current system of ESG ratings at EU level,
making them true Sustainability Ratings, or “ESG 2.0”. Thus, we call EU policy-makers to design a
Regulation that:
1.
ensure ESG ratings follow a double materiality approach, therefore taking into
consideration companies’ exposure to ESG risks, but also and most importantly their ESG
impacts on the outside world.
2.
sets minimum sectoral quality thresholds for ESG ratings.
3.
ensures that ESG ratings attribute more importance to absolute performance of
companies in relation to their impact materiality, in addition to assessing companies’ risk
exposure compared with their peers.
4.
ensure differentiated “E”, “S”, “G” ratings linking “E” to alignment with a 1.5°C pathway
(=GHG emission reduction) and the phase-out of fossil fuels.
5.
is coherent with existing legislation such as the Corporate Sustainability Reporting
Directive, the Sustainable Finance Disclosure Regulation and the EU Taxonomy, so that
data disclosed by companies and financial institutions is computed in meaningful ratings
that can be used by investors and asset managers to channel their funds to most
sustainable companies.
6.
addresses the lack of transparency and comparability of ESG ratings and the governance
of the ESG rating market (market concentration, conflicts of interests, etc).
7.
enforces
independent reviews and factual verification on the ground, promote
stakeholders engagement and involvement, including from reputable Civil Society
Organisations.
With the newly proposed regulation on ESG rating activities, European policymakers have a significant
opportunity to fix glaring problems with ESG ratings. Creating an appropriate regulatory regime for
ESG ratings providers and data services is a chance to finally get ESG ratings to contribute to the
objectives of the European Green Deal and the Paris Agreement, while setting gold standards at global
level in order to attract and direct investments towards long-term decarbonisation goals.
A briefing by
2

Table of contents
1. What are ESG ratings and why do they matter?
4
2. State of play: the fallacy of ESG ratings
5
2.1. Double materiality: lack of focus on impact
6
2.2. Divergences: same company, different ratings
6
2.3. Biases: unduly favouring large companies
7
2.4. Striking the right balance between top-down and bottom-up ESG strategies
8
3. ESG ratings in the transport sector: what is dysfunctional
9
3.1. The car industry - greener than green
10
3.2. Shipping: on the same boat as cleantech companies
11
3.3. Aviation
13
4. Towards Sustainability Ratings and ESG 2.0
14
4.1 Policy recommendations
14
A briefing by
3

1. What are ESG ratings and why do they matter?
ESG ratings are defined as a comprehensive measure of a company’s long-term commitments towards
environmental, social and governance issues. ESG rating agencies (or providers) rate companies, issuers,
securities or funds based on their ESG policies, systems and measures, using data they gather from
multiple sources including ESG data providers, company's publication, media, NGOs or other
stakeholders.
However, they are today mostly dedicated to measuring the companies’ resilience to long-term
environmental, social and governance risks - in other words, the impact of these ESG dimensions on the
company itself, what we call inward materiality. As outlined below, the ESG impacts of the company - on
nature, people and the planet - are much less taken into account.
Nonetheless, despite their problematic limitations, ESG ratings are still the main reference indicators in
the sustainable finance sector to allocate capital. Industry data show that this is the fastest growing
segment of the asset managers industry, overtaking most of the old investment strategies (exclusions,
themed funds, Best in Class etc). While the growth in sustainable investing keeps accelerating, it is
estimated by Bloomberg that one third of total assets under management, the world’s financial wealth, is
invested in sustainability’s most popular proxy: ESG themed funds. Still, it is important to highlight that
ESG themed funds do not currently provide any guarantee of sustainability. According to a more
conservative evaluation of PwC1, global asset managers are set to expand their ESG-related assets under
management to $33.9 trillion by 2026, from $18.4 trillion in 2021. This will represent 21.5% of total global
Assets Under Management.
Therefore, ESG investing is rapidly going from being a market niche to mainstream. This growth is unlikely
to stop soon, as a factor driving the consumption of ESG data is the introduction of regulatory frameworks
imposing comprehensive and granular reporting requirements for financial institutions and the products
that they distribute, such as the Sustainable Finance Disclosure Regulation (SFDR), the UCITS and PRIIPs
Regulations or the EU Taxonomy of sustainable investments. For instance, the SFDR imposes mandatory
ESG disclosure obligations for asset managers.
De facto, third party ESG data providers and their ratings set the perspective of risks and opportunities
and hold the potential to foster the capital inflow towards sustainable activities.
With their increase in popularity, ESG ratings are undergoing increased scrutiny and have recently been
hit by a wave of criticism. In fact, firstly, they are - rightly so - accused of being a major cause of
greenwashing in markets. We will see in Section 3 that this is also valid for the transport sector.
1 PwC (2022), “Asset and Wealth management revolution 2022” (Link).
A briefing by
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Secondly, ESG investing is facing a strong backlash in the USA where it is more and more fiercely opposed
by Republicans. For instance, the Florida governor - and potential running candidate for the next US
presidential election - Ron DeSantis signed a controversial anti-ESG bill that bans the state of Florida from
issuing ESG or green bonds. The law also stops pension funds from considering ESG criteria when voting
at companies’ annual meetings2. Such backlash makes this agenda an increasingly politicised one, as ESG
criteria are being associated with criticisms over so-called “Woke capitalism”3. In the European Union,
this controversy is to date far less prominent than in the US.
The role played by ESG rating agencies is crucial despite the lack of binding framework for their
operations. As we do not expect ESG ratings to go away anytime soon, we believe it is vital to deal with
them, by using them and analysing them, to come up with a meaningful reform. As such, they cannot be
ignored, and they should at least not be left to their current state.
2. State of play: the fallacy of ESG ratings
As previously highlighted, ESG ratings play a crucial role in sustainable investment and influence
investors’ strategic decisions. However, a literature review quickly reveals that they often fail on their
purpose of being a reliable and comparable measure of sustainability performance and that they
therefore lead to the wrong capital allocation. As pointed out by the European Securities and Markets
Authority (ESMA), the ESG ratings market is “unregulated and unsupervised”4.
Among several studies on the matter, in November 2020, the European Commission outsourced and
published a “Study on Sustainability-Related Ratings, Data and Research”5. This study from the
consultancy firm ERM, based both on desk research and stakeholders’ engagement, gives an in-depth
overview of the functioning and classification of ESG providers, data, methodologies and the use of
sustainability-related
products
and
services.
Alongside
the
description of major players and
methodologies, it also depicts the primary criticisms identified by stakeholders, representing an obstacle
to a virtuous development of the market.
T&E took part in various stakeholder consultations, including a call for evidence organised by the
Commission in 2022 on the matter, and expressed a clear view on the flaws and inconsistency of ESG
ratings to evaluate sustainability performance of companies. The fact that companies in highly polluting
industries - like carmakers - can obtain high environmental scores from some ESG rating agencies leads to
investor confusion and highlights the need for greater transparency and the development of legal
definitions.
5 ERM (November 2020), Study on Sustainability-Related Ratings, Data and Research, (Link).
4 ESMA (28.01.2021), Letter to the European Commission (Link).
3 Corporate Governance Institute, “What is woke capitalism” (Link).
2 Financial Times (05.05.2023), Moral Money
A briefing by
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There are several factors that hinder the ESG ratings’ transparency and reliability. Among others, we
highlight in this section significant divergences when defining scope, measurement and weight, as well as
several biases and the failure to adopt a double materiality approach in the assessment.
2.1. Double materiality: lack of focus on impact
Currently, the prevailing focus of ESG ratings is primarily limited to assessing the environmental, social,
and governance risks associated with a company's business operations. In addition, ESG ratings classify
companies’ performance on a relative basis, with a peer-to-peer comparison of risk exposure within the
same sector. An absolute6 evaluation would be key to address the real performance of the company itself
in relation to its external impacts.
This approach often results in greenwashing and the misallocation of capital. It is noteworthy that the
majority of rating providers lack a comprehensive double materiality approach, which entails considering
both the risks faced by the company and the impacts the company has on ESG factors. Regrettably, the
absence of a correlation between ESG ratings and the tangible effects of companies on people and the
environment has led to a distorted evaluation of companies' sustainability performance.
Furthermore, the double materiality principle serves as a fundamental rationale behind the cutting-edge
and ambitious nature of current EU legislation on sustainable finance. In fact, the EU's regulatory
framework is widely acknowledged as the most progressive and far-reaching on a global scale, precisely
due to its commitment to addressing both the internal risks faced by companies and the external impacts
they have on broader ESG considerations.
2.2. Divergences: same company, different ratings
In the context of ESG ratings, a divergence refers to a difference or disparity in the ratings assigned by
various ESG rating agencies or providers to the same company.
The "Aggregate Confusion: The Divergence of ESG Ratings" paper7, study of reference in the field, identifies
three primary sources of divergence: scope, measurement, and weight, with the measurement being the
most significant contributor at 56%. According to the study, scope divergence refers to the situation where
ratings are based on different sets of attributes, measurement divergence indicates a situation where
rating agencies measure the same attribute using different indicators and weight divergence emerges
7 Berg, Florian and Kölbel, Julian and Rigobon, Roberto (15.08.2019), “Aggregate Confusion: The Divergence of ESG
Ratings”, Available at SSRN (Link).
6 Absolute vs relative evaluation of performance - the relative approach focuses on comparative peer-to-peer analysis (i.e.
the best-in-class within a given sector). The absolute approach allows an evaluation of the company’s performance itself in
relation to given science-based key performance indicators. From an impact materiality perspective the second one gives a
more relevant indication of the actual sustainability performance of the company.
A briefing by
6

when rating agencies take different views on the importance of attributes. These divergences, as defined
in the research, result in low agreement in ESG ratings provided by different vendors. Consequently
causing uncertainty and challenges for investors in making informed decisions, thus reducing the
effectiveness and relevance of ESG scores, both for investors and companies.
Among these divergences, the arbitrary allocation of value to the selected key performance indicators
(KPIs) recurrently differs across ESG providers. In this regard, rating agencies may prioritise certain ESG
dimensions over others based on their own assessment frameworks or stakeholder priorities. These
subjective judgments can lead to inconsistencies in weightings and, subsequently, in overall ratings.
Furthermore, every sector and industry results in a unique set of impacts, risks and opportunities and
providers may adjust their weightings based on sector specific considerations. Even if this can be
considered as a good practice, it rarely brings relevance to the right factors, as outlined in the section 3
below addressing major problems in ratings for the transport industry.
In addition, several transparency and discrepancy issues arise from the data sourcing to develop ESG
rankings. In fact, its scarcity and difficult accessibility often induce the adoption of diverse estimation
methodologies and the use of proxies from providers, thus heightening the already existing problems.
A detrimental consequence of divergences is that investors can search for a rating that fits their purpose
and enable them to perpetuate business as usual, basically performing “ratings-shopping”.
All the above outlined inconsistencies pose obstacles to effectively evaluating and comparing ESG
performance across different sectors and entities. Therefore, it is essential for policy makers to recognise
the need for a more cohesive and standardised approach. This entails strengthening data collection and
analysis frameworks, as well as promoting the adoption of uniform methodologies, also entailing KPI
weighting.
By actively addressing these concerns, policy makers can foster greater transparency, accuracy and
comparability in assessing ESG performance, thereby facilitating informed decision-making and
promoting sustainable practices.
2.3. Biases: unduly favouring large companies
There are three main types of biases that can lead to unreliable and inconsistent ESG ratings. As also
outlined in the ERM study, they relate to the size of the company, the geographical location of the
company and their industry-based approach.
The first one implies that larger companies often obtain higher ratings than SMEs, not necessarily because
they perform better, but generally due to their capability to invest more resources in sustainability
reporting.
A briefing by
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The second one consists in awarding greater ratings to companies located in regions with higher
mandatory reporting requirements, mostly due to the quality of the data available.
Finally, the industry bias, where the tendency of providers to determine KPIs at the sector level fails to
account for the specificity of different companies. While the latter does point towards some measure of
harmonisation, which is positive, it is still key to have some flexibility to account for different business
models. Without considering the particularities of each and every business and therefore adapting the
methodology, a risk arises of ending up with distorted ESG ratings.
2.4. Striking the right balance between top-down and bottom-up ESG
strategies
A top-down strategy for ESG ratings involves taking a close look at macro-level elements, like sector-wide
risks and opportunities, developments in a specific industrial sector (changes of leadership and market
shares, etc) and regulatory changes impacting a sector. Third-party ESG providers investigate these larger
factors when assessing material ESG matters for each industry. Therefore, they play a major role in the
sustainability assessment of a company’s performance.
On the other hand, a bottom-up strategy concentrates on the details, such as business-specific
information, protocols, and procedures at company level. After detecting the ESG matters for each
industry, third party ESG raters investigate individual businesses inside that sector, determining their
performance and risk exposure by utilising company-specific data.
To date, most ESG rating agencies opt for either one or the other approach. Still, to mitigate the risk of
discrepancies due to the rater's choice of approach, a methodology finding the right balance between
top-down and bottom-up approaches would be more judicious. Coupled with a focus on impact
materiality, the adoption of a hybrid approach holds the potential to significantly improve the quality of
ESG ratings.
In a recent report “Rate the Raters 2023, ESG ratings at a Crossroads”8 published by ERM, the authors
highlight that “Despite high usage, investors and corporates are also frustrated by the shortcomings of ESG
ratings. Black box rating methodologies and questionable data accuracy are particular concerns. Our
research indicates building tension. Most surveyed investors and companies have only modest confidence
that ESG ratings accurately reflect sustainability performance, while a sizable minority of corporates feel
they do not. Views on the overall usefulness and quality of ESG ratings are also slipping”. This underlines
that the major problems around ESG ratings are still present and need to be fixed. We believe that the
new regulation proposed by the European Commission is the right instrument to drive that change.
8 ERM (2023), “Rate the Raters 2023, ESG ratings at a crossroads” (Link).
A briefing by
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The example of Sustainalytics is quite telling about the challenges faced by ESG rating agencies. It is
widely considered as one of the leading ESG rating agencies in the world. It was acquired in 2020 by
Morningstar Inc., a major US-based rating agency who is now its sole owner.
Sustainalytics claims to balance the objectivity and accuracy of ESG data and to follow a comprehensive
and systematic approach. However, we have observed gaps and encountered limitations in its ratings and
methodology. Three of these main methodological shortcomings are identified below:
1.
Material ESG issues: Sustainalytics focuses mostly on financial materiality while leaving behind
the impact materiality. Hence, it misses the double materiality perspective, which has now
become a cornerstone in the EU Sustainable Finance agenda.
2.
Industry-specific approach: Sustainalytics' methodology takes into account the unique ESG risks
and opportunities within each industry. This industry-specific approach enables the rating
provider to more accurately assess a company's performance in the context of its peers. Still, it
makes it complicated to compare the impacts and risks of activity sectors between themselves. In
practice, it means that the most sustainable company in a poorly performing industry may receive
a high ESG rating, even if its overall sustainability could be very doubtful.
3.
Forward looking metrics: Sustainalytics tries to provide forward-looking assessments that
analyse a company's preparedness for ESG risks and potential future benefits. This method can
provide a competitive advantage to large companies or financially stable companies while leaving
behind small and mid-size companies. This shortcoming is still counter-balanced by the fact that
forward-looking metrics, by helping consider risks and impacts over the mid- to long-term, are
more likely than traditional short term credit ratings to take into account the risk of investing into
stranded assets, for instance fossil fuel related assets in the transport and energy sectors.
3. ESG ratings in the transport sector: what is dysfunctional
The transportation sector is a crucial European industry and a significant contributor to carbon
emissions, accounting for 21% of global emissions. In the transport industry, ESG ratings are used to
measure and assess the ESG performance of companies, funds dedicated to decarbonising the sector,
and investment portfolios. However, rating inconsistencies currently hinder accurate performance
evaluation and create confusion, discouraging investment in most sustainable activities or those
accelerating their climate transition towards decarbonisation.
Additionally, the dispersion of ESG ratings can obstruct the market's ability to accurately price a firm's
ESG performance. This can bear an impact on asset prices through investor preferences or fundamental
value relevance (i.e., the ability of information disclosed by financial statements to capture and
summarise the value of a company).
A briefing by
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Not only do the current failings of ESG ratings negatively impact stakeholders who are seeking to make
their activities and investments in the sector more sustainable, they are also the main enabler of
greenwashing. This is highlighted in the case studies below.
3.1. The car industry - greener than green
As demonstrated in a report9 published by T&E in September 2022, ESG ratings show no correlation and
fail to capture the carmakers sector’s true impact. Despite CO2 emissions, together with air pollution,
being possibly the most relevant of environmental KPIs for the sector, this specific parameter only
represents, for example, 0.6% of the ESG rating for S&P and a similar % for MSCI. Unsurprisingly,
despite transport being Europe’s largest CO2 emitter and our research showing that when lifecycle
emissions are duly considered carmakers are actually “oil companies in disguise”, car manufacturers
score very high with ESG raters on environmental grounds.
Despite Life Cycle emissions of a vehicle (the ‘use of good sold’ category, in particular) representing 98%
of total emissions, in ESG ratings this key indicator only receives a <1% weight (e.g., only 0.6% in S&P’s
ESG assessments). Hence emissions, the most material and impactful factor in the industry, are largely
irrelevant in ESG ratings.
9 Transport & Environment (September 2022), Oil companies in disguise.
A briefing by
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Below a graph extracted from the report highlights the dissenting distribution of E scores according to
various ESG raters.
What is striking is the discrepancy between medium to high ratings of OEMs and their environmental
performances. For instance, Toyota is receiving rankings above 50/100 (when re-scaled to a 0-100
score where low values are less sustainable), while a recent study from the International Council on
Clean Transportation shows that it is a laggard in the race to electrification and does not have a
comprehensive strategy to switch its production from Internal Combustion Engines to Electric
Vehicles10.
The same discrepancies identified in the car manufacturing sector-related ratings can be found also
in other transport sectors. Below an analysis of the shipping and aviation segments.
3.2. Shipping: on the same boat as cleantech companies
It is well recognised that the shipping industry significantly contributes to global GHG emissions and
other environmentally harmful pollutants and is traditionally a little regulated sector. In 2020, the
maritime sector accounted for about 2.8% of global GHG emissions11.
One would therefore expect ESG ratings to measure the often poor sustainability performance of
companies operating in this sector accordingly. However, the current ESG framework does not
capture their true sustainability, similarly to the automotive industry.
11 Faber, J. et al. (2021), Fourth IMO GHG Study 2020, International Maritime Organization (IMO).
10 International Council on Clean Transportation (31.05.23), The Global Automaker Rating 2022 (Link).
A briefing by
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In fact, while the ESG pillars' weighting may differ, the assessment of risks for the company is still
given more importance than the impact the company has on people and the environment. For
instance, MSCI clearly states that their “ESG ratings assess how well companies manage risk
compared with their peers, not across industries. Some investors will favor or avoid certain sectors for a
variety of financially or values-driven reasons. Within a given industry, however, investors want to know
how companies compare with one another based on their exposure to, and management of, financially
relevant ESG risks.” 12
We conducted an analysis of the publicly available ESG ratings of major container shipping
companies operating in Europe, such as Hapag-lloyd, Maersk and Cosco, and it clearly emerged that:
-
There is not enough information publicly available to conduct a meaningful comparative
analysis between different companies’ ratings;
-
The attributed scores diverge across ESG rating providers;
-
The weighting methodologies are not transparently defined for the sector;
-
The majority of the performance assessment still focuses on the risk exposure of the
different companies to ESG factors rather than on their ESG impact. This does not provide
meaningful information about the actual sustainability of the companies considered.
Considering that the companies investigated are experiencing exponential growth, it would be of
utmost importance for ESG ratings to reflect their actual E, S and G performance and the solidity of
their decarbonisation and transition targets and plans. This would enable sustainable investors to
take informed investment decisions, ultimately steering investments towards the best-in-class
companies.
In addition, it is noteworthy that in 2022 - according to MSCI ESG Ratings and Climate Search Tool,
CDP scores on climate change and Sustainalytics company’s ESG Risk Ratings - the giant Danish
shipping company Maersk was rated very similarly to cleantech companies such as Vestas Wind
systems or SSE Renewables. From an environmental impact perspective, cleantech companies focus
on developing and providing environmentally friendly solutions or technologies that have a positive
impact on the environment. They often aim to reduce carbon emissions, promote renewable energy,
or improve resource efficiency. In contrast, container shipping companies primarily focus on
transporting goods across the globe, which inherently involves significant carbon emissions and
environmental impact. In this context, the similar ESG ratings attributed to the companies operating
in two different sectors might therefore be misleading for investors.
A meaningful ESG reform at European level should define minimum environmental thresholds for
key economic sectors. For a very specific sector like shipping and the maritime industry, we
recommend to attribute high scores to the most material environmental KPIs, these being:
12 Data retrieved from MSCI website on 09/06/23.
A briefing by
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1.
Climate change mitigation and in particular GHG emissions in all their scopes (Scopes 1, 2,
3) relevant for all companies active in the shipping sector and, targeting in particular:
-
For operators the fuel used on board the ship and considering a Well-to-Wake
approach (at least 30% of E pillar);
-
For manufacturers the emissions linked to the construction of the ship (at least 30%
of E pillar);
-
For shipping companies responsible for the ship, the emissions related to the
decommissioning of the ship (at least 30% of E pillar).
2.
Air pollution, including emissions of SOx, NOx and particulate matter (at least 20% of E
pillar).
3.
Age of the ships and replacement ratio.
4.
Information about sustainable fuels used on board, including their origin and type.
5.
Waste management, mostly for manufacturing purposes (the ships need to have specific
systems on board).
We also recommend enhancing the providers’ assessment of the absolute performance of
companies. In fact, the evidence of companies’ disclosure on the relevant topics is not enough to
appropriately assess the attainment of targets in line with their decarbonisation pathway.
3.3. Aviation
We assessed the ESG evaluation of sustainability performance across aircraft manufacturers like Airbus
SE, ThyssenKrupp AG and Safran SA. From our research we draw similar conclusions than in other
transport sectors on systemic issues encountered.
Overall, with reference to the climate change topic, all companies considered seem to be exposed from
medium to high risk according to Sustainalytics and most of them score quite high according to CDP and
MSCI ratings.
However, does this provide stakeholders with the information they need to allocate money on
sustainability leaders rather than laggards? We believe that investors should be able to understand the
A briefing by
13

sustainability of the sector as a whole, including its absolute impact, as well as the absolute and relative
performance of individual companies within the industry.
To assess the climate and environmental credentials of companies active in the aviation sector we advise
to take into account the following indicators as most relevant:
For aircraft manufacturers:
1.
Climate change mitigation and in particular Scope 3 GHG emissions;
2.
Use of resources and percentage of circularity;
3.
Percentage of zero emissions technologies.
For airlines:
1.
Climate change mitigation and in particular Scope 3 GHG emissions, including non-CO2
emissions;
2.
Information about Sustainable Aviation Fuels used, including their origin and type;
3.
Age of the fleet and replacement ratio;
In conclusion, regulators must address discrepancies in ESG ratings and ensure that sustainable finance
practices in the transport industry are accurately evaluated. In order to achieve meaningful scoring
results, we reiterate the importance of carrying out, in addition to peer-to-peer analysis, absolute
performance assessments of both overall sectors and individual companies. It would be for example
more substantial to evaluate companies’ performance in relation to emissions with reference to
commonly established decarbonisation targets at EU level.
By doing so, they will promote transparency, foster more sustainable capital allocation, and effectively
contribute to global environmental and social goals.
4. Towards Sustainability Ratings and ESG 2.0
The ESG ratings’ system needs to be re-designed and binding legislation will play an accelerating role in
this regard. The lack of a timely intervention is likely to nullify most of the EU's efforts to steer capital
flows towards sustainable economic activities and thus to reach the objectives set by the EU Green Deal.
Without a reform towards ESG 2.0, users of ESG data and ratings should adopt a cautious approach and
limit their reliance on ESG ratings.
4.1 Policy recommendations:
The new legislation on ESG rating activities at EU level should be enhanced with a set of binding criteria
and principles for ESG rating companies, in addition to putting in place a stronger governance for this
growing market. Robust and reliable assessments of ESG performance could prevent the risk of corporate
greenwashing. Our key recommendations to policy-makers are the following:
A briefing by
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1.
To be considered as a real evaluation of sustainability performance, ESG ratings shall follow the
double materiality principle, thus taking into account both companies' inward risks and outside
impacts. A legally binding definition of ESG ratings at EU level should enshrine this principle into
the new Regulation.
2.
The EU should focus on setting minimum sectoral quality thresholds for ESG ratings. The
KPIs included in ESG ratings should be relevant, meaningful and aligned with the key
sustainability challenges faced by corporates. Metrics should be chosen based on their
materiality, impact and ability to provide insights into sustainability practices and risks.
One option is to establish a minimum percentage of impact indicators (e.g. 50%) and to attribute
minimum weight to material factors in high impact sectors. For example: for car manufacturers, a
minimum weight should be assigned to the very material issue of vehicle life-cycle emissions (e.g.
60% instead of 0,6%).
The “E” in ESG ratings should be clearly linked to alignment with a 1.5°C pathway and the gradual
reduction of GHG emissions. The phase-out of high impact activities like operations in the fossil
fuels sector should be a prominent indicator, while building on the Do No Significant Harm
principle enshrined in the EU Taxonomy Regulation to identify activities at odds with climate
objectives.
Full correlation between ESG ratings should not be an objective in itself. Still, it is necessary to
make sure that crucial materials issues (like Scope 3 emissions for transport industry) are
awarded a much higher weight than anecdotal criteria on the use of office furniture by a firm’s
employee for instance.
3.
The EU should ensure that ESG ratings attribute greater importance to
absolute
performance of companies in relation to their impact materiality, in addition to assessing how
well companies manage risk compared with their peers in their sectors of operations. To have a
comprehensive overview on companies’ performance, investors shall access information that
assesses both the absolute performance of the company and the sector, and the relative
performance of the company in relation to its peers.
4.
The ESG proposal shall take into account and be coherent with existing legislation such as
the EU Taxonomy Regulation, the Corporate Sustainability Reporting Directive (CSRD) and
future European Sustainability Reporting Standards (ESRS).
The CSRD and its sector-specific standards will help address the problems of lack of standardised
ESG data reported by companies and allow for better comparison of companies within the same
industry. The KPIs identified in the ESRS should form the basis of the criteria that ESG rating
agencies use in their rating methodologies.
A bridge should also be created between the Taxonomy scores and ESG scores. ESG rating
agencies could disclose, for example, what percentage of the E score is based on factors deemed
material in the Taxonomy. A similar score could be disclosed for the use of the S and G indicators
extracted from the CSRD-related KPIs, as the Taxonomy Regulation will not provide a framework
for S and G indicators in the coming years. This bridge could alleviate the risk that the entire
architecture of EU’s sustainability disclosures becomes a tick boxing exercise whilst markets keep
using poor ESG ratings.
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5.
The new EU Regulation shall provide a set of governance reforms including:
❖Improving transparency on the methodology used by the providers, including on data
sources and verification methods for company’s data;
❖Requiring issuers of ESG ratings and assessments in Europe to be registered and
supervised by a public authority. ESMA is the best placed institution to act as a supervisor,
because it is already in charge of credit rating agencies (CRAs) at EU level, and integrated
in its work plan the gradual inclusion of ESG factors in credit ratings. For environmental
indicators, ESMA should cooperate with other agencies such as the European
Environment Agency.
❖Setting up controls by supervision authorities at EU level in order to hold ratings agencies
accountable (via sanctions on abusive practices for instance)
❖Reducing risks of conflicts of interests that may arise in the business models of ESG
providers
❖Put an end to the reliance on data provided, and even corrected, by the assessed entity.
Instead, require independent reviews and factual verification on the ground, promote
stakeholders engagement and involvement, including from reputable Civil Society
Organisations.
❖Addressing the structure of the market: concentration of a market that is currently
undergoing a process of consolidation by a handful of operators - mostly large,
oligopolistic US firms whose primary business is credit rating.
In conclusion, the EU needs to ‘connect the dots’ and complete its sustainability disclosure architecture
with clear guidelines to translate all of the above-mentioned data into basic, transparent and reliable
sustainability scores. This is what ESG ratings were meant to be and are currently mistaken for.
The growth in demand for ESG products needs to be matched with sound regulatory requirements, so
that their reliability and quality can significantly improve.
Sustainability Ratings are currently the missing piece in the sustainable finance puzzle at EU level. The EU
has made progress, despite severe setbacks and greenwashing attempts, in progressing towards a better
definition of what “sustainability” means and in getting corporates and financial institutions to disclose
granular information about their ESG risks and impacts. Setting up sound and coherent mandatory
requirements for ESG ratings would complement these past efforts, while providing a much-needed
operational tool for investors. We now need ESG 2.0 in Europe, more than ever.
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Further information
Name: Giorgia Ranzato
Title: Sustainable Finance Manager
Transport & Environment
giorgia.ranzato@transportenvironment.org
Mobile: +32(0) 4 882 03 312
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