Sustainable investing: here's how to use ESG ratings

Understanding what

The enduring nature of an investment has been determined by the Sustainable Financial Disclosure Regulation (SFDR) of March 10, 2021.
"What contributes to an environmental or social objective is sustainable, without causing significant harm to other environmental or social objectives, and within a company that applies good governance practices ».
This is the definition that the Financial Markets Authority endorses on its website.

ESG Ratings

ESG (Environmental, Social, Governance) ratings allow an investor to get an idea of the sustainability of an issuer or a product thanks to numerical benchmarks.

This knowledge is a valuable aid in minimizing mistakes and better driving investment decisions.
Most of the time, these ratings are based on the extra-financial analysis models of independent evaluators who publish them, such as Refinitiv, which offers a system based on an evaluation of the 3 ESG pillars, from 0 to 100.

Some French banks also have their own teams of analysts and internal evaluation methods (F.R.e.D at Crédit Mutuel...). For example, F.R.e.D proposes a model based on the evaluation of 5 pillars: ESG, economy and society and the company's commitment to a socially responsible approach.

ESG Ratings: still a long way to go!

While it is clear that this lack of regulatory determinants can lead to its share of abuses (favoritism, lack of clear normative benchmarks...), the investor must know that sustainable finance and the consideration of extra-financial criteria are two « arts » still extremely young.

Even if the ESG ratings of certain issuers may seem laughable, they have - beyond the simple merit of existing - a « data » anchor that comes from the information delivered by companies or NGOs: CSR (corporate social responsibility) reports, annual reports, independent studies...

Indeed, we must not kid ourselves: yes, Greenwashing exists. But it would be harsh to say that ESG ratings do not help to drive a more ethical and responsible trajectory in the world of finance.

Beyond ethical questions: why sustainable investing is important

According to a 2021 AMF survey, 76% of French people consider the environmental impact of their investments to be important. Sure, but an investor uninterested in extra-financial issues cannot also ignore sustainable finance.

The reason is twofold:
1. Sustainable projects are simpler and less costly to finance (green bonds, advantageous rate green loans) than projects that do not take into account ESG criteria. Translation: a lower financing cost can only help to improve the return on investment.
2. Issuers better rated from an ESG point of view are less subject to controversy. The risk of controversy and therefore of impact on the value of investments is less significant.
Every individual investor, even the most reluctant in terms of sustainability, must take into account ESG ratings in their selection of issuers or products. They will help to bring quality to their decision-making and to optimize the risk-adjusted return on their investment portfolio.

Some tips for wisely using ESG ratings

Given the challenge of incorporating ESG ratings, the meticulous investor can start their responsible approach by taking certain avenues.

Understanding ESG Ratings
To give credibility to non-financial ratings and make informed choices, the individual investor can delve into the methodology used by analysts.

Source: Refinitiv
On the environmental requirements side, the use of resources, CO2 emissions for example will be fundamental criteria.
For the social component, Refinitiv assesses the ability of companies to improve quality of life at work, to respond to fundamental human rights and to develop sustainable products. For governance, the financial data provider focuses on the relationship between stakeholders, management and CSR approach.

Knowing about the labels and the SFDR regulation of funds

In France, there are a series of labels that allow the investor to easily ensure the non-financial nature of the products they encounter.
These include Greenfin, ISR and Finansol labels.

These labels, awarded by independent bodies accredited by the state (Afnor certification or Novethic for example), or by governmental organs, are clear and effective guarantees regarding ESG ratings.
Nevertheless, this does not prevent the investor from going beyond the certifications and apprehending the issuer's activity and projects with a more subjective critical eye.

For instance, some investors are very excited when it comes to analyzing the trajectory of TotalEnergies in renewable energy, while others point out certain controversial projects in more traditional energy sectors (Uganda, Mozambique...).

On the funds' side (OPC...), the SFDR regulation offers an interesting classification that every investor must know:

- Article 9 : sustainable investment objective
- Article 8 : considers environmental or social criteria
- Article 6 : no declaration of consideration for environmental or social criteria, no sustainable investment objective.

Using the traditional sustainable strategies

If you have trouble trusting rating or labeling agencies, you can build your own securities or funds (OPC...) portfolio by using strategies that industry professionals use:
1. Best-in-class, meaning investing in the best-rated issuers' projects in their sector),
2. Best-in-universe, meaning investing in the best issuers without sector discrimination),
3. Exclusion, which means excluding companies operating in controversial sectors (traditionally tobacco, arms, pornography or fossil fuels). Note, however, the potential for sector biases that can arise in the construction of portfolios!

Reimagining our relationship with financial products: the ethical requirement

It seems difficult today for an individual investor not to participate in the rapid sustainable shift that the world of finance is taking.

With a demanding and uncompromising citizen approach, their investment choices contribute to the improvement of ESG ratings over the years.

Their action thus helps to better define extra-financial semantics, provide more clarity within their financial portfolio (and thus reduce its risk), meet the climate challenge but also and above all, participate in the construction of a more ethical world.