ESG ratings: all you need to know about MSCI rating methodology

‍MSCI Inc. is a leading global investment research firm headquartered in New York City, offering a range of services including investment indexes, portfolio analysis tools, and ratings on ESG, equity, loans, mutual funds, ETFs, and countries.

One of its most important offerings is the MSCI ESG Ratings, which evaluate a company's ESG performance against peers and provide insights into ESG risk exposure and risk management.

As ESG factors increasingly affect investment decisions, understanding MSCI's rating methodology is crucial for companies, investors, analysts, and anyone interested in ESG investing.

In this article, we'll take a deep dive into MSCI's rating methodology, and explore how MSCI ratings can impact investment decisions.

Let's get started!

How do the MSCI ESG Ratings work?

MSCI rating system

The MSCI ESG Ratings put companies in one of seven letter categories: 

• Leader—“A company leading its industry in managing the most significant ESG risks and opportunities,” categorised as AAA or AA
• Average—“A company with a mixed or unexceptional track record of managing the most significant ESG risks and opportunities relative to industry peers,” categorised as A, BBB, or BB
• Laggard—“A company lagging its industry based on its high exposure and failure to manage significant ESG risks,” categorised as B or CCC

Process and methodology

MSCI’s ESG ratings look at 1000+ data points (KPIs, policies, targets, etc.), considering exposure metrics (how exposed is the company to industry material issues), management metrics (how is the company managing each issue), and 35 ESG key Issues.

A specialised ESG research team provides insight throughout the rating process, and MSCI conducts systematic monitoring and quality review of information, as well as a formal committee review. 

The 35 key issues, shown in the diagram below, are centered on the intersection between a company’s unique material issues and industry-specific issues, meaning that the MSCI ESG ratings assess companies on their performance relative to peers within their industry, for more accurate comparison (all companies are assessed on Corporate Governance and Corporate Behavior).

More specific details on MSCI metric calculation and a breakdown of factors considered can be found on MSCI’s ESG Metrics Calculation Methodology page. 

While key Issues are identified by looking quantitatively at each industry as a whole, individual companies’ exposure to each issue will vary based on their business mission and scope.

MSCI ESG Ratings calculate each company’s exposure to key ESG risks across different components of a business' value chain: including core product/business segments, the locations of its operations, and other relevant measures such as outsourced production or reliance on government contracts.

For instance, MSCI states in their methodology document that while their model looks at the averages for “externalised impacts such as carbon intensity, water intensity, and injury rates,” “[c]ompanies with unusual business models … may face fewer or additional key risks and opportunities [and c]ompany-specific exceptions are allowed” in some situations.

Thus, industry-specific Key Issues may not be the same for all companies within the industry (although there should at least be significant overlap).

Company-specific data also depends on exposure and management metrics, both of which MSCI scores on a scale of 0-10. 

Issues are also weighted based on impact and time horison of their risks or opportunities. MSCI determines whether the industry is a major or minor contributor overall to an issue, and identifies a risk or opportunity as:

• ‍short-term (less than 2 years)
• medium-term
• or long-term (5+ years)

‍and takes that information into account when delivering ESG scores. Other considerations in MSCI ESG ratings include assessment of opportunities and controversies. 

Tools and resources

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MSCI offers tools and guides to its rating system free of charge. More details on rating methodology can be found on the MSCI ESG Ratings Methodology pdf, and the list below provides some other useful links. 

• ESG Ratings & Climate Search Tool
• ESG Industry Materiality Map
• ESG Funds Rating Search Tool 
• Index Profile Search Tool 

Who uses the MSCI ESG Ratings?

How MSCI Clients use the ESG Ratings

MSCI ESG Research is used by over 1,400 investors worldwide; the MSCI web page lists asset managers, owners, banks, corporates, insurance companies, and wealth managers among their client categories.

Due to the MSCI ESG ratings’ focus on financial materiality (eg. factors that will impact a company’s bottom line), the ratings are geared towards persons or groups that are concerned with financial performance and risk assessment.

ESG Ratings are especially helpful for investors in supplementing financial analyses, for screening select risks or sustainable practices, and as additional information on companies that are currently in an investor's portfolio. 

MSCI points out that while ESG disclosures in self-reports from individual companies offer helpful information, self-reported ESG information consists of maybe “50% of the full suite of information needed to evaluate ESG performance”.

MSCI uses other independent sources of information–such as company characteristics as defined by an outside agency, and data on product risk and event data, to name a few factors–beyond corporate disclosure to provide investors with a more detailed picture.

According to MSCI surveys, common client use of MSCI ESG ratings include: fundamental and quantitative analyses, portfolio construction, risk management, ESG benchmarking, financial index-based product development, and customer engagement and thought leadership. 

Benefits for for-profit companies

ESG ratings are not something that companies necessarily request- independent ESG rating agencies such as MSCI or Sustainalytics measure company performance with publicly available information and information sourced directly from the company.

As mentioned above, ESG ratings are especially helpful for investors and asset managers; however, companies also benefit from earning a high ESG rating. 

MSCI ESG Ratings aim to measure a company's management of financially relevant ESG risks and opportunities. High ESG score indicates that best practices are being followed in all ESG areas and a company has little to no internal or external problems.

A good ESG score signifies that a company is meeting best practices in each ESG category and has a low negative impact on people or the planet.

Conversely, a low ESG rating points to areas of concern that the company likely needs to address in order to reduce risk and remain competitive.

Companies that fail to manage ESG risks have historically experienced higher costs of capital, more volatility, and accounting irregularities.

Thus, while a low or unsatisfactory ESG score is never desirable, it can still be helpful in identifying areas for improvement. 

Even before being useful for improving practices, the research methodology behind ESG ratings can also be used by companies to start their CSR strategy.

For example, MSCI's Materiality Map can be used by a company to help identify its material CSR issues. MSCI ESG Ratings is providing a public assessment of material issues per industry. 

How can companies view or change their MSCI Rating?

MSCI ESG ratings are available online on their ESG Rating & Climate Search Tool, where interested parties can search either by company name or ticker.

MSCI monitors companies on an ongoing basis and conducts annual reviews, so companies have the opportunity to raise their ESG score each year by taking positive action on materially relevant sustainability issues and publicising the results of their actions.

Note that new information may be reflected as quickly as on a weekly basis, especially if a controversy or important governance event has occurred. 

Since ESG ratings are conducted by independent agencies with public data sources—such as companies with annual financial reports, sustainability reports, proxy reports, information from various monitored media outlets, data sets from governments, regulatory organisations, and NGOs—companies generally do not need to take the initiative in the assessment process.

MSCI does reach out to companies as a part of the data review process, and will typically alert the company 6-8 weeks in advance of MSCI’s annual ESG Rating Action update. 

Some proactive action that a company can take if they want to either join an ESG rating database or improve their rating might include:

• ‍establishing a clear ESG governance structure to oversee the management of ESG policies and systems
• reviewing relevant publicly available data that might be used in a rating analysis, compare ESG ratings across different rating agencies
• or review agency-specific rating criteria and try reaching out to the rating agency for additional details. 

Options for facilitation and aid from third-parties

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