ESG indices provide a valuable measure of a company’s sustainability across different areas and call attention to its success or failure in meeting these criteria.
By Leonel Chapa Mata
Financial indices describe and measure market and company performance around the world. A financial or market index includes a set of companies selected according to pre-established rules. The four major index providers are the S&P Dow Jones Indices, MSCI, FTSE Russell, and Bloomberg. Smaller providers include Morningstar, CRSP, and Solactive.
Index providers also may offer ESG indexes, which are market indices created by evaluating companies based on environmental, social, and governance criteria. Each index provider uses different methodologies to construct their indices and determine under which conditions a company can be included and labeled as ESG-compliant.
There are no commonly accepted rules for defining how a company meets ESG criteria. Each index provider prioritizes different aspects of sustainability. As a consequence, each firm compiles their indices and assigns a score to companies using different rules. For example, MSCI has 10 themes and 37 factors it considers when developing a company’s ESG score. FTSE Russell has 14 themes, and S&P has 23 criteria.
The ESG indices for each of these three respective providers include the MSCI World SRI Index, the FTSE4Good Global Index, and the Dow Jones Sustainability World Index. The MSCI ESG index can be used as a good benchmark to understand which factors companies should be considering to be included in ESG indices. Launched in May 1990, it became the first sustainable index in the marketplace. To understand the factors that lead to higher ESG scores for biotech companies, we can choose the MSCI World SRI Index, one of the first global ESG indices. The MSCI World SRI Index is constructed by subjecting companies to a combination of values-based exclusions and a best-in-class selection process.
Public companies benefit from being included in ESG market indices. There is evidence that inclusion in or exclusion from a stock index, such as the S&P 500 Index, impacts share price. Studies from Markit have found that companies added to the S&P 500 experience increases in their share values, while exclusions decrease stock performance.
Pharmaceutical companies can take actions to prevent being excluded from indices and to improve their chances of being included in leading indices such as the MSCI World SRI Index. Companies should not be involved in nuclear power, tobacco, alcohol, gambling, weapons, civilian firearms, GMOs, fossil fuels or adult entertainment activities. In addition, companies should strive to have an MSCI ESG rating of “BB” or above, and an MSCI ESG Controversies Score of 1 or above. Biotech companies should avoid serious controversies involving the environmental, social, or governance impact of their operations, products and services.
MSCI’s best‐in‐class selection process selects the top companies based on the MSCI ESG ratings. These ratings are sector-specific, and use an ESG Industry Materiality Map that accounts for the current Key ESG Issues and determines their contribution to companies' ESG ratings. This means that in energy and mining, for example, there is a greater focus on the environmental impact; in retail there is an emphasis on the supply chain; in technology, the emphasis is on cybersecurity and privacy.
The ESG ratings of biotech companies are derived from material ESG risks encompassing the following areas: Governance—ownership and control, board, pay, accounting, business ethics, and tax transparency; Social—human capital development, product safety and quality, access to healthcare; Environmental—toxic emissions and waste.
Biotech companies seeking to achieve an ESG score of at least “BB” should be looking to improve sustainability performance in these areas so they can qualify for the MSCI industry benchmark. For example, biotech companies should have established staff-related policies to attract and retain diverse individuals from around the world. In addition, biotech companies should collaborate in promoting responsible supply chain management and better business conditions across the industry.
Inclusion in an ESG index provides a strong material incentive for biotech and pharma companies to promote best practices in their corporate sustainability strategies. Index inclusion is a validation of progress that enhances a company’s market profile and raises its public recognition among investors, increasing positive exposure and attracting capital investments. With increasing investor appetite for sustainable investment products soaring as ESG assets surpassed $35 trillion in 2020, companies have good reasons to improve their ESG practices, attaining inclusion and high ratings in the leading market indices.
Are you looking to raise your company’s sustainability profile and improve its ESG report scores? Reach out and share your challenges with The Global Imprint and we’ll work with you to expedite and optimize your ESG reporting and results.