A firm's financial performance and ESG score are linked: ESGRisk.ai chief

In a Q&A, Sankar Chakraborti, who is also the group CEO at Acuite Ratings & Research, explains why ESG scores matter to investors

As the globe battles climate change and its adverse effect on the sustainability of life and business on the planet, investors and lenders now also want to know a company’s performance on environmental, social and governance (ESG) factors besides financial ratings. This has turned ESG ratings into a new growth opportunity for rating agencies. Last year Acuite Ratings & Research launched ESGRisk.ai to provide ESG ratings to India’s top listed companies. Sankar Chakraborti chairman, ESGRisk.ai & group CEO, Acuité Ratings & Research tells Krishna Kant from Business Standard why ESG scores matter to investors.

Financial ratings and their implications are well understood but why should investors and other stakeholders also focus on ESG ratings of companies?

It has become increasingly evident in recent years that a company’s performance on environmental, social and governance (ESG) factors is highly correlated with its financial performance. This is because various components of ESG factors highlight the risk that a company faces as well as the future. Secondly, both investors and lenders are gravitating towards responsible investing and lending, thereby focusing on ESG assessments. ESG Ratings play a crucial role to enable objectivity in such decisions.

ESG ratings by ESGRisk.ai foster informed decision-making in choosing ESG investments, assessing a particular companies or industries performance, reviewing ESG business strategies and identifying need for policy interventions.

Can you elaborate on the differences and similarities between financial ratings and ESG ratings?

Credit ratings or financial credit ratings have a history of over 150 years, whereas ESG ratings are not even a decade old. Financial credit ratings aim to provide an independent opinion on a borrower's ability and willingness to pay back its debt in full and on time, usually with respect to an instrument or security issued by the borrower. Usually such an opinion is forward looking up to 1-5 years’ horizon.

ESG ratings, in essence, focus on organisations’ long-term sustainability and their capacity to carry out its operations and grow, keeping environmental, societal and governance risks and opportunities in mind. ESG ratings use a very detailed set of factors which are proven to have material impact on financial performance of the organisation.

Should retail investors also bother about ESG scores of companies before investing in stocks?

We are seeing an increasing trend among people choosing to buy products and services of companies that are environment-friendly and socially responsible. This trend has also started percolating to investors. This trend is ably supported by regulatory emphasis on green practices with respect to not just governance practices but environment and social consciousness too. Corporate India is taking a note of it. At this point of time however, institutional investors have to take the lead in incorporating responsible and sustainable principles of investing in their policies. And it will be the responsibility of these institutions to educate retail investors about these principles properly so that they are not misled.

Does ESG score also reflect in the financial metrics of companies?

There is an evident correlation between financial performance and ESG scores. A study by ESGRisk.ai shows that since the pandemic began, returns from Top 50 ESG companies are 131%, compared with the 117% yield on Nifty 50, for the period of April, 2020 to October 10, 2021. During the Covid-19 related selloff that began in Q1, 2020, ESG companies outshone broader benchmarks than most of the non-compliant companies, making investments in ESG compliant companies more stable.

Organisations committed to satisfying multiple stakeholders' interests and improving sustainability practices invariably have high ESG scores and superior financial performance as opposed to their peers. A strong ESG strategy enhances brand reputation, contributes to the company’s top-line growth and drives shareholder engagement. All of these affect ROI besides reducing revenue risks.

Many agencies have now forayed into ESG Ratings, how does Acuité ESG rating compare with that of your competitors?

Our ESG rating arm ESGRisk.ai is India’s first such agency. Our uniqueness lies in our framework that is India focused. There are many factors where India stands apart and such differences are considered by our methodology.

Secondly, our methodology and data collection are extremely comprehensive. Our ESG scores are based on a wide range of ~739 data points and 525 indicators that have been selected and assigned weights based on their materiality and relevance to specific industries. Each score provides a summary of the corporate’s ESG strategy, initiatives, results, and negative news across 19 critical themes including energy, emissions, water, environmental management, ESG reporting, human rights, community, supply chain, and shareholders’ rights among others.

Lastly, we follow the 'subscriber pays’ business model. So anybody who wants to subscribe becomes a subscriber and pays for the information one accesses. This ensures complete objectivity and independence of our opinions.

Who is your target audience for ESG Ratings?

Institutional Investors like mutual funds, FIIs, PEs who are keen to construct ESG portfolio, launch ESG Mutual Funds or focus on impact investing are our primary target group.  Similarly, Banks that are focused on green lending find our ratings extremely useful in decision making. Finally, corporates who seek to assess ESG risk, do gap analysis or need training on ESG principle compliance also reach out to us.

How big an opportunity is this for Acuité and can it help you close the gap with incumbents in the rating business?

We don’t know how big this is going to be but the initial response from the various stakeholders have been beyond our expectations. We are fast expanding our subscriber base and engaging with our stakeholders on a regular basis. This year, ESGRisk.ai completed an ESG assessment of the top 500-listed companies and, going forward, we plan to increase the ESG rating of top 1000 listed companies. We also have plans to include ESG assessment and ratings of International companies in our bouquet, thereby becoming a global service provider.

Lastly, we are lucky to pursue a business that’s going to play at least a small part in making the world of business and the planet a better place in future.