The company’s performance on ESG issues – which includes three main indicators – is becoming an increasingly important factor for stakeholders and in investment decisions. In the future, issues regarding climate, environmental, social, and governance will be the main considerations for investors in investing, because organizations with a good ESG score are considered better prepared to anticipate future risks and opportunities. Today, many studies have been conducted showing that companies that comply with ESG principles are companies that have high operating risk low and will be more sustainable, even in less favorable financial conditions.
The ESG criteria are considered to help investors consider ‘unmeasured’ or ‘underrepresented’ environmental, social, and governance topics when making investment decisions. It reveals data that traditional financial analysis does not usually take notes, i.e. it talks about corporate sustainability in a broad sense.
With increasing interest in valuation using ESG criteria, investors need a way to objectively assess a company’s ESG performance. This has led to the development of a few ESG Rating Agencies that rate companies globally based on a company’s ESG performance.
This ESG rating is designed to help investors identify and understand financial ESG risks to their business. In other words, quantitative material is qualitative. Companies are evaluated based on publicly available information such as media sources and annual reports, with scores given for each material topic ‘E’, ‘S’ and ‘G’, in addition to the overall score.
This unique score is used by investors as a proxy for ESG performance. Companies that score well on ESG metrics are believed to be able to better anticipate future risks and opportunities, are more inclined to long-term strategic thinking, and focus on long-term value creation.
How to use ESG Score and how it is implemented in Indonesia?
When investors use ESG scores in their investment strategy, the consequences of a poor rating on a company can be a significant issue to consider. For example, if a company gets a bad rating from one data provider and an ESG rating, its stock may be considered an ‘unsustainable asset’ by investors and removed the Company’s stock from their investment portfolio. If many investors follow this step, it could eventually have a negative impact on a Company’s share price.
In Europe, almost 50% of assets are managed under the criteria of ‘responsible investment’, understand the ESG score as very important, and its use is increasing year by year. Meanwhile in Indonesia, although ESG has been introduced for more than a decade, not many people know or use it. Meanwhile, the Indonesia Stock Exchange (IDX) only requires all issuers listed on the IDX to submit ESG reports in 2022. The policy is to encourage competition with stock exchanges in other countries.
In addition, IDX also issued the IDX ESG Leaders Index to emphasize IDX’s commitment to encourage ESG practices and become one of the milestones in implementing sustainable investment in Indonesia.
The stock exchange authority confirmed that the IDX ESG Leaders Index was built based on an ESG risk assessment which measures the extent to which the Listed Company has implemented ESG, based on the risk exposure in each business field. This step is also taken to develop sustainable investment and improve ESG practices in the Indonesian Capital Market.
It is also important to recognize that ratings can be an invaluable internal benchmarking tool to guide decision making and improve sustainability performance. An evaluation by an external expert of a company’s ESG performance provides an independent view of its performance, and how it performs in comparison to competitors and co-workers. This can be a strong incentive to act and steps towards improving performance.
Furthermore, the assessment can provide a valid source of information to assist internal supporters in promoting change – as well as highlighting specific areas of weakness and strength of the company.