MSCI ESG Ratings Definition, Methodology, Example

What Are MSCI ESG Ratings?

MSCI ESG ratings are a comprehensive measure of a company’s long-term commitment to socially responsible investments (SRI) and environmental, social, and governance (ESG) investment standards. In particular, the MSCI ESG ratings focus on a company’s exposure to financially relevant ESG risks.

ESG and SRI investing prioritize a company’s positive contributions to its community, the environment, and social impact. Scoring companies along ESG dimensions allows socially conscious investors to screen potential investments to fit with their investment goals and values.

Understanding MSCI ESG Ratings

ESG investing has become increasingly popular over the past decade. The US SIF: The Forum for Sustainable and Responsible Investment reports that in 2020, more than $17 trillion of professionally managed assets were held in sustainable assets, around one-third of all assets under management. With its growing popularity, data providers have also created various scoring criteria upon which to rank and grade potential ESG investments, allowing socially responsible investors to make more informed decisions when choosing which companies, ETFs, or mutual funds to include in their portfolios.

Alongside MSCI, several other financial firms have developed their own proprietary ESG scoring models, including Russell Investments and Standard & Poors (S&P), among others.

MSCI’s ratings decompose ESG into its three thematic components: the environment, social responsibility, and corporate governance.

Under the environmental dimension, key issues include:

• contribution to climate change
• a company’s utilization of "natural capital" (such as biodiversity and raw materials sourcing)
• pollution and waste management
• use of green technologies and renewable energy

Under social:

• health, safety, and human capital development
• product and consumer safety
• community relations
• social opportunities

And, under governance:

• corporate governance fairness and accountability
• transparency and ethics

How Do MSCI ESG Ratings Work?

Analyzing metrics within each of these key issue items, MSCI scores the companies that it rates on each key issue from zero to ten, with zero indicating virtually no exposure and ten representing very high exposure to a particular ESG risk or opportunity. MSCI also evaluates companies on exposure to controversial business activities (e.g., weapons, tobacco, gambling, etc.). The data informing these scores are obtained from corporate filings, financial statements, and press releases in addition to almost half of all data coming from hundreds of third-party media, academic, NGO, regulatory, and government sources.

Scores based on individual metrics are aggregated, weighted, and scaled to the relevant industry sector to arrive at an intuitive letter-based grade, akin to lettered credit scores issued by credit rating companies.

Source: MSCI

According to MSCI, a "leader" (rated AAA & AA) indicates a company leading its industry in managing the most significant ESG risks and opportunities. "Average" (rated A, BBB, or BB) companies are described by a mixed or unexceptional track record of managing ESG risks and opportunities relative to industry peers; while a "laggard" (rated B or CCC) trails its industry based on its high exposure and failure to manage significant ESG risks.

Real-World Example of MSCI ESG Ratings: Tesla, Inc.

To illustrate how MSCI ESG ratings can be used by investors, let’s take a look at the electric vehicle producer, Tesla, Inc. (TSLA). The company earns an overall grade of "A," putting it on the higher end of "average" among the 41 companies in the car industry rated by MSCI. Digging into its rating, Tesla excels in corporate governance and environmental risks, maintaining a relatively small carbon footprint while both utilizing and investing in green technologies. The company scores an average grade for product quality and safety, with the company making headlines in the past for exploding batteries, undesirable crash test ratings, and accidents involving the cars’ self-driving "autopilot" feature – although CEO Elon Musk has publicly announced a commitment to improving both driver and bystander safety.

What truly drags down Tesla’s MSCI ESG rating is its below-average score for product quality and safety. The battery banks in its cars have been known to spontaneously combust and the National Transportation Safety Board (NTSB) has accused Tesla for neglecting driver safety, calling certain Autopilot features "completely inadequate" and citing Autopilot as the probable cause of several deadly crashes involving Tesla cars.

Tesla has also been criticized for its labor management practices. For instance, the company has been found to be in violation of labor laws by blocking unionization, and that it has violated the National Labor Relations Act multiple times. More recently, the company’s leadership has come under fire for keeping plants open and unsafe during the COVID-19 pandemic, leading several of its workers to come down with the illness.

Despite earning only an "average" score, it is worth noting that only one company covered in the auto industry (including both automobiles and auto parts) currently earns "leader" status on MSCI’s ESG ratings – the French auto parts maker, Valeo SE.