Background

In February 2018, Institutional Shareholder Services, Inc. (ISS), the largest U.S. proxy advisory firm, announced that an Environmental and Social (E&S) QualityScore Disclosure & Transparency Signal would be reflected in proxy research reports that it publishes regarding certain U.S. and foreign publicly traded companies, supplementing the Governance QualityScore that ISS already publishes. ISS initially published an E&S QualityScore for approximately 1,500 companies in areas that it considers most exposed to E&S risks, including Energy, Materials, Capital Goods, Transportation, Automobiles & Components, and Consumer Durables & Apparel, which were in place for the 2018 proxy season. In May 2018, ISS expanded its coverage to a total of 4,700 public companies around the world in a variety of industry groups, potentially leading to greater influence of this metric in the 2019 proxy season.

This assessment by ISS is part of a trend of increased focus on Environmental, Social, and Governance (ESG) factors involving public companies, which may affect the investment and voting decisions of certain investors. ISS is one among multiple groups evaluating companies on ESG factors, which generally promote corporate social responsibility. However, its E&S QualityScore, along with its Governance score, could prove to be among the most influential as its reports and recommendations are widely subscribed to and followed by institutional investors. ISS has published the Governance QualityScore for the past few years, evaluating public companies’ overall governance quality and risk, including their compensation/remuneration, shareholder rights and takeover defenses, and audit and risk oversight, and the E&S QualityScore represents a further expansion in the scope of its review of ESG factors and of companies in general.

Methodology

The E&S QualityScore provides multiple decile-based 1 (high) to 10 (low) scores, with a higher score representing relatively higher quality disclosure and transparency practices rated within specific industry groups. The scores measure the depth and extent of companies’ public disclosure (including information in SEC filings, Sustainability and Corporate Social Responsibility Reports, publicly available company policies and on company websites), and also identify key disclosure omissions. The E&S QualityScore may change regularly based on ISS’s ongoing review of disclosure materials and developments in its review methodology. Since the score is based on how a particular public company fares against others in its industry, it may decrease if its peer companies improve their E&S-related disclosure.

Note that a public company’s E&S QualityScore will not affect ISS’s proxy voting recommendations, which is also the case for its Governance QualityScore.

Top-level scores are assessed for each of the Environmental and Social pillars, as well as for each category within each pillar, as follows:

Environmental Management of Environmental Risks and Opportunities Carbon and Climate Natural Resources Waste and Toxicity
Social Human Rights Labor, Health, and Safety Stakeholder and Society Product Safety, Quality, and Brand

The ISS E&S QualityScore Key Issues release includes details about the subcategories within each category above, as well as the various issues they assess within each subcategory. Companies’ expectations with respect to disclosure practices will be defined by their applicable industry groups. The evaluation framework covers over 380 individual factors, of which approximately 240 will be used for each industry group.

The evaluation is limited to the quality of the disclosure with respect to E&S issues, which investors may use to inform their investment and voting decisions, and does not directly assess corporate practices itself. According to the ISS E&S QualityScore Q&A, such disclosure “showcases the company’s understanding of its environmental and social risks, along with its preparedness to face and mitigate them, and drastically increasing its responsibility and accountability.” Furthermore, limited disclosure may be a signal of poor practices, and does not allow for a meaningful comparison of ESG factors against peer companies. However, companies’ participation in or endorsement of ESG-focused initiatives may positively affect the score, because ISS believes they “have a threshold of conduct for participation, give access to shared learning on best practice from industry peers, and confirm and reaffirm the company’s commitment to expected standards.” Companies do not get credit for non-public ESG information and policies in this assessment.

The E&S QualityScore is included in relevant public companies’ ISS Benchmark Proxy Analysis, along with their Governance QualityScore. Unlike the Governance QualityScore, the E&S QualityScores is not currently presented on external channels such as Yahoo! Finance, though they may expand to external websites in the future, and such channels already include other ESG metrics and analyses.

Take Away

Though E&G QualityScores were published for 1,500 companies during the 2018 proxy season, it is too early to determine how much influence the metric has, both on public company disclosure and the behavior of investors. However, a low score may signal room for improvement in disclosure practices and how companies fare against their peers. It could also encourage investors and others to push for more robust ESG disclosure and better corporate practices. Because E&S QualityScores are not currently widely reported, they may only influence institutional investors that subscribe to ISS reports at this time.

Companies have the opportunity to verify their data against the information evaluated by ISS in determining the E&S QualityScore, so it may be worthwhile to confirm that they are getting credit for all of their ESG-related public disclosure in this assessment.