A comparison of MSCI and sustainalytics ESG Ratings

Environmental, Social, and Governance (ESG) ratings have become crucial tools for investors aiming to incorporate sustainability into their investment strategies. Among the prominent providers of ESG ratings, MSCI and Sustainalytics are widely recognized¹. Despite their shared goal of assessing the ESG performance of companies, they employ distinct methodologies and frameworks². This article explores the key differences and similarities between MSCI and Sustainalytics ESG ratings, offering insights into their unique approaches and implications for investors.

MSCI ESG Ratings

Methodology and Framework³:

1. Rating Scale: MSCI uses a letter-grade scale ranging from AAA (leader) to CCC (laggard), assessing companies relative to their industry peers.
2. Pillar Weights: MSCI considers three main pillars: Environmental, Social, and Governance. Each pillar’s weight varies by industry, reflecting the materiality of different ESG issues.
3. Data Sources: MSCI employs a mix of publicly available data, company disclosures, and proprietary research. This includes regulatory filings, sustainability reports, and media sources.
4. Risk Exposure and Management: MSCI evaluates both the exposure to ESG risks and the management of these risks. Companies are assessed on how well they manage ESG risks relative to their industry peers.

Key Features:

1. Industry-Specific Analysis: MSCI’s approach tailors the ESG rating to industry-specific risks and opportunities, offering a nuanced view of a company’s ESG performance.
2. Integration with Financial Metrics: MSCI integrates ESG analysis with financial performance metrics, helping investors understand the potential impact on long-term financial performance.
3. Controversies Assessment: MSCI considers ESG-related controversies and their severity, impacting a company’s overall ESG rating.

Sustainalytics ESG Ratings

Methodology and Framework⁴:

1. Rating Scale: Sustainalytics uses a risk rating scale from 0 (negligible risk) to 100 (severe risk), categorizing companies into five risk levels: negligible, low, medium, high, and severe.
2. Pillar Weights: Similar to MSCI, Sustainalytics evaluates companies based on Environmental, Social, and Governance pillars, but the weights are more uniform across industries.
3. Data Sources: Sustainalytics relies on a combination of public information, company disclosures, and third-party sources, including news and NGO reports.
4. Risk Exposure and Management: Sustainalytics focuses on a company’s exposure to material ESG risks and how well these risks are managed, considering both the magnitude and likelihood of ESG issues.

Key Features:

1. Absolute Risk Assessment: Unlike MSCI’s relative industry-based assessment, Sustainalytics provides an absolute measure of ESG risk, enabling comparison across industries.
2. Management and Unmanaged Risk: Sustainalytics differentiates between managed and unmanaged risks, highlighting areas where companies can improve their ESG performance.
3. Controversy Involvement: Sustainalytics monitors company involvement in ESG controversies, which can significantly impact the risk rating.

Comparison

Transparency:
Sustainalytics emphasizes transparency in its methodology. The company provides detailed reports explaining how it arrives at specific ratings. Investors can access information on specific ESG issues, controversies, and risk factors. MSCI’s methodology is more opaque, which makes it challenging to compare ratings⁵.

Approach to ESG Integration:
MSCI’s relative industry-based assessment is beneficial for investors seeking to compare companies within the same industry. This approach accounts for sector-specific ESG risks and opportunities, making it easier to identify industry leaders and laggards. Conversely, Sustainalytics’ absolute risk rating is advantageous for cross-industry comparisons, providing a clear view of a company’s ESG risk level regardless of its sector.

Risk Management Focus:
Both MSCI and Sustainalytics emphasize the importance of risk management in their evaluations. However, MSCI’s integration with financial metrics offers a direct link between ESG performance and financial outcomes, aiding investors in understanding the potential impact on returns. Sustainalytics’ distinction between managed and unmanaged risks provides a clear roadmap for companies to enhance their ESG strategies.

Data and Controversies:
The reliance on diverse data sources by both providers ensures comprehensive ESG assessments. MSCI’s detailed analysis of controversies and their severity offers insights into potential reputational risks, while Sustainalytics’ emphasis on controversy involvement highlights ongoing ESG challenges faced by companies.

Conclusion

MSCI and Sustainalytics ESG ratings serve as vital tools for investors aiming to incorporate sustainability into their investment decisions. While MSCI’s relative industry-based approach and integration with financial metrics provide a detailed view of industry-specific ESG performance, Sustainalytics’ absolute risk assessment and focus on managed versus unmanaged risks offer valuable insights across industries. Understanding the methodologies and unique features of each provider can help investors make informed decisions aligned with their sustainability objectives.

References

1. Wolters Kluwer (2020, May 28). The different ESG ratings and what they mean. https://www.wolterskluwer.com/en/expert-insights/the-different-esg-ratings-and-what-they-mean ↩︎
2. Prall, K. (2021, August 10). ESG Ratings: Navigating Through the Haze. CFA Institute. https://blogs.cfainstitute.org/investor/2021/08/10/esg-ratings-navigating-through-the-haze/ ↩︎
3. MSCI (2024). ESG Ratings – Measuring a company’s resilience to long-term, financially relevant ESG risks. https://www.msci.com/sustainable-investing/esg-ratings ↩︎
4. Sustainalytics (2020). Overview of Sustainalytics’ ESG Risk Ratings. https://connect.sustainalytics.com/hubfs/SFS/Sustainalytics%20ESG%20Risk%20Ratings_Issuer%20Backgrounder.pdf ↩︎
5. Fund Library (2022, August 18). Pros and cons of ESG ratings. https://www.fundlibrary.com/Articles/Detail/pros-and-cons-of-esg-ratings/1227 ↩︎