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As the effects of climate change manifest across the globe scrutiny on businesses' conduct has increased — by authorities, financiers, shareholders and the public at large. The pressure of this focus has resulted in demand for transparency and accountability in business governance, in line with environmental, social and governance (ESG) values. While ESG provides the parameters for responsible and ethical business performance, sustainability practice forms the substance.
Measuring business impact: What is an ESG score?
In response to demands for businesses to disclose their ESG credentials — and avoid penalties for greenwashing or making misleading statements ‒ credentialled ratings and research providers can deliver analysis and a score based on a range of criteria1.
Many of these providers use a standardised set of ESG criteria which can help companies benchmark their performance against others. Using algorithms and analysis, providers convert ESG metrics such as a business's carbon emissions, board diversity and safety procedures into individual scores which are merged into a combined ESG rating or ESG score. Scores typically range from 0 to 100, with a score of less than 50 considered relatively poor and more than 70 considered good.
ESG scores are calculated based on a variety of factors and impacts in the following areas:
- environmental issues: energy use, carbon emissions and other pollution, waste management including plastic and electronic waste, water usage, biodiversity and land use, and other climate change vulnerabilities and impacts.
- social issues: employee relations and labour practices, human rights, community engagement, diversity and inclusion policies, worker safety, product safety, consumer financial protection, and data protection and privacy.
- governance issues: executive compensation, board diversity, accounting practices, shareholder rights, business ethics and anti-corruption policies.
ESG scores are increasingly becoming an industry standard, making them more likely to appear alongside companies' quarterly or annual reports as studies show that consumers are prepared to pay more for sustainable goods2. ESG assets under management are expected to increase to over a fifth of the global total by 2026, driven by millennials' market demand3.
Accordingly, investors are demanding new tools to assess how companies perform on ESG performance, and businesses need to be able to demonstrate that they are walking the talk.
Beyond ESG scores — understanding a business's sustainability
Businesses are paying far more attention to the rising expectations, risks, and opportunities tied to sustainability (ESG and climate change) factors. As a result, sustainability (ESG and climate change) governance is a standout priority.
Sustainability risk assessment is not simply another ESG score. There are key differences in purpose, methodology and output.
A sustainability risk assessment approach is an alternative and/or complement to ESG score measurement and applies different and deeper considerations to the opportunities and risks in the areas affecting sustainability.
The impacts a business may have on sustainability can be direct, through its operations, or indirect, through its supply chains. Analysing these effects and relationships can provide a clearer view of a business's sustainability and give decision makers valuable information and insights beyond an ESG score.
Increasingly businesses are expected to be responsible for their supply chains and to understand and manage the environmental and social impacts associated with each stage of the chain.
Doing this requires the collaborative involvement of all the parties to the supply chains process, from raw product to over-arching policies, a 'landscape' approach to the development of practical solutions that integrate consideration of biodiversity and ecosystems into business decision-making.
Comparing an ESG score to a sustainability risk assessment approach
| ESG Score | Sustainability Risk Assessment | |
| Purpose | Providing a uniform measure, the ESG score allows comparing and benchmarking of companies based on their ESG practices and performance. | To help businesses understand the materiality and potential magnitude (financial and non-financial) of sustainability risks, prioritise them, and develop strategies to reduce them.
Beyond scoring, it provides actionable insights and recommendations to improve understanding of risk and the management of sustainability risks, and to make informed decisions on sustainability practices. |
| Methodology | A simplified and standardised rating procedure of an entity's overall sustainability / ESG performance. | A systematic qualitative and quantitative assessment of sustainability risk factors, including physical and transitional climate change risks, supply chain disruption, labour practices, skills for the future and importantly, governance. |
| Output | Numerical rating or score that represents an entity's relative sustainability / ESG risk performance. Investors, analysts, and stakeholders often use these scores for quick comparisons. | Detailed report or analysis that highlights specific sustainability risks, their potential magnitude of impact, and recommendations for risk mitigation and management. Businesses can use the report to inform financial (e.g. Insurances), operational, or reputational improvements. |
How Gallagher can help
Assessing sustainability risks and considerations involves taking a comprehensive strategic and operational view of the complexities and impacts across the business. Gallagher offers Sustainability Risk Services to support businesses in facing these risks and opportunities.
