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ESG ratings are used to evaluate how far companies have integrated and applied ESG factors into the management of their business, and these evaluations are then used as part of the investment process when deciding what securities to buy. Different industry providers have developed different approaches to how they score ratings for their solutions, but they all need to fundamentally consider the following issues:

 Identify the most material ESG risks and opportunities that a company and its industry are facing. (I cover materiality earlier in this chapter.)

 Quantify how exposed a company is to those key risks and opportunities.

 Determine how well a company is managing the key risks and opportunities.

 Conclude what the overall picture for a company is and how it compares to similar companies within its sector or geographical region.

This allows an objective consideration of any negative externalities that companies in an industry may face, and highlights potential, unforeseen costs apparent in the mid to long term. Equally, understanding negative externalities should help emphasize ESG factors that present opportunities for companies in the mid to long term. This section highlights the metrics around ESG and hones in on some of the “good, bad, and ugly” issues relating to how data is applied. Chapter 14 has even more information on ratings and metrics.