ESG (Environmental, Social, Governance) is the most-discussed and least-understood framework in finance. Critics call it incoherent; defenders call it foundational. Both are partly right. ESG is incoherent if you treat it as a unified score; it is essential if you treat it as a structured way to look for material non-financial risks.
What the three letters actually capture
- Environmental: GHG emissions (Scope 1/2/3), water use, biodiversity impact, waste, pollution, resource intensity.
- Social: workforce safety, labour relations, diversity, supply-chain human-rights, customer privacy, product safety, community impact.
- Governance: board independence, executive compensation, audit quality, anti-corruption controls, ownership structure, related-party transactions.
Materiality: the lens that makes ESG useful
Not every ESG issue matters for every company. Water intensity is material for a beverage company; trivial for a software company. Cybersecurity is material for a bank; less so for an asphalt manufacturer. The SASB Materiality Map — now part of ISSB — codifies which sub-issues are financially material per industry. This is the single most useful 'how do I make ESG operational' document.
Single vs double materiality
Financial materiality (single materiality): an issue is material if it affects the company's enterprise value. Used by SASB, ISSB, and US-aligned standards. Double materiality: also material if the COMPANY affects the world (e.g. emissions that harm the climate). Used by EU CSRD. The choice is consequential — under double materiality, companies must disclose impacts even if those impacts don't affect their own profitability.
Why ratings diverge
Research by MIT and ESRI (Berg, Kölbel, Rigobon, 2022) found that ESG ratings from the top providers correlated only 0.54 — far lower than credit ratings (0.99). The drivers of divergence are methodological, not random:
- Scope: which issues each rater includes (some include lobbying, some don't).
- Measurement: how each issue is quantified (e.g. 'employee turnover' from disclosures vs from web-scraping).
- Weights: how the issues are weighted into a composite score (and weights differ by industry).
Don't outsource the judgement
A single ESG rating is not a decision-making artifact. It is a weak signal, useful for screening at scale but not for individual position decisions. Read the underlying disclosures, look at the material issues for the industry, and form your own view. Analysts who outsource to ratings get burned when the rating updates lag a real-world event by quarters.
Exercise
Pick a listed company and look up its ESG ratings from MSCI, Sustainalytics, and one other provider. Note the divergence. Then look up the SASB materiality map for that industry: what are the 3-5 material issues? Read the company's disclosure on each. Where do you agree with the ratings, and where do you see something the ratings missed?