Are ESG Ratings a Signal of Progress or a Ritual of Compliance?

Editor: Daisy Amanda, Agnes Sulistya, Sharah Saputra (LCI Team)

The ESG Rating Paradox

Over the past decade, ESG ratings have become widely used to evaluate a company’s sustainability performance. They are increasingly incorporated into investment strategies, internal risk management tools, and corporate disclosures. According to  the International Organization of Securities Commissions (IOSCO) the growing influence of ESG ratings on capital allocation has made them a key feature in global financial markets. 

Yet questions remain: do ESG ratings truly reflect meaningful progress, or are they becoming part of a tickbox routine? As sustainability gains traction across sectors, it is worth considering whether these ratings are driving real improvement—or merely shaping perception.

What Is an ESG Rating?

At its core, an ESG rating is designed to evaluate how a company manages Environmental, Social, and Governance issues. It combines various indicators—ranging from emissions and energy use to employee rights and board composition—into a structured assessment.

These assessments are built from a combination of:

• Self-disclosed information, such as sustainability reports and internal policies;

• External sources, including news media, civil society, and regulatory data, and

• Inherent business attributes, like geographic exposure or product portfolio.

  
  

However, ESG ratings are not uniform. Each provider uses its own methodology, focus areas, and data sources, which can lead to different results for the same company. For example:

• MSCI ESG Ratings assess a company's exposure to performance and industry-specific ESG risks and how well it monitors those performance and manage risks relative to peers, focusing heavily on risk management and resilience.

• Sustainalytics (by Morningstar) offers ratings that separate risk exposure and risk management, enabling users to distinguish unmanaged ESG risks from broader performance.

• EcoVadis specializes in supply chain sustainability assessments, often used by companies to evaluate suppliers on labour conditions, environment, ethics, and sustainable procurement.

• CDP Scores, while not ESG ratings in the strictest sense, are widely referenced for assessing climate disclosure, water security, and deforestation risk, based on direct questionnaires.

These differences underscore the complexity of ESG measurement. While all providers aim to enhance transparency and accountability, the scope, purpose, and methodology vary significantly, highlighting the need for users to understand what a particular rating actually reflects.

Why ESG Ratings Matter for Business

ESG ratings can contribute to building transparency and accountability, provided they are used as part of a broader commitment to responsible business practices. For investors, they offer a way to assess long-term risks and opportunities beyond financial performance and to compare companies on ESG factors across sectors. For businesses, these ratings can support internal evaluations, help identify areas for improvement, and guide sustainability reporting. They also serve as a reference point to communicate performance to stakeholders.

Bringing in the Regulatory Perspective

The growing reliance on ESG ratings has prompted increased attention from regulators and standard-setting bodies. In 2021, IOSCO published a report highlighting concerns over the lack of transparency in methodologies, potential conflicts of interest, and the inconsistency of ESG ratings. IOSCO called for increased regulatory oversight and issued a set of recommendations to improve the integrity and reliability of ESG-related products.

In response, several jurisdictions have taken concrete steps. The European Union, for example, adopted the Regulation on the Transparency and Integrity of ESG Rating Activities in April 2024. This regulation requires ESG rating providers operating within the EU to be authorized and supervised by the European Securities and Markets Authority (ESMA). It also mandates public disclosure of methodologies, data sources, and potential conflicts of interest to make ESG scores more consistent and trustworthy.

Similarly, in the United Kingdom, the government announced its intention to regulate ESG rating providers through a dedicated legislative framework. The forthcoming regulation, to be overseen by the Financial Conduct Authority (FCA), will align with IOSCO’s international principles and aims to enhance transparency and accountability across the ESG rating landscape.

These developments reflect a broader recognition: that as ESG ratings increasingly influence capital flows and corporate strategies, they must meet high standards of clarity, comparability, and oversight. The move toward greater standardisation and supervision is a critical step toward strengthening the reliability of ESG metrics and building long-term stakeholder trust in the system.

In Practice: Recognizing the Limitations

ESG ratings provide a useful framework for evaluating sustainability performance, offering a degree of structure and comparability in an area that is inherently complex and constantly evolving. In many cases, these ratings have helped companies pay closer attention to non-financial risks and encouraged greater transparency, particularly in areas that were previously viewed as peripheral to core business operations.

However, concerns continue to surface regarding how ESG ratings are applied in practice. This may lead companies to focus more on the presence of policies or disclosure practices, rather than on actual outcomes or measurable impact. In addition, variations in methodologies among providers can lead to inconsistent assessments of the same company, making it difficult for stakeholders to interpret results with confidence.

In certain situations, this may result in ESG ratings being perceived more as procedural frameworks.—meeting reporting requirements without necessarily driving substantive change. These limitations do not negate the value of ESG ratings, but they do underscore the need for greater alignment between measurement frameworks and real-world sustainability performance.

Even so, companies are not passive recipients of these evaluations. By understanding how ESG scores are constructed and where limitations exist, businesses can engage more critically and use the insights as part of a broader strategy. ESG ratings should not be treated as final judgments, but rather as tools to reflect on priorities, guide improvement, and identify areas where internal practices may diverge from external expectations.

Rating with Purpose

As sustainability becomes more integrated into business strategy and investment decision-making, the tools used to measure progress must evolve accordingly. ESG ratings remain an important part of this landscape—but their true value lies in how they are used. Rather than serving as a final stamp of approval, ESG ratings are most effective when treated as a starting point for reflection, dialogue, and continuous improvement.

For companies, the goal should not be limited to achieving high scores. Instead, ESG assessments can be leveraged to inform decisions, strengthen stakeholder engagement, and clarify a company’s role in delivering long-term, sustainable value. This requires moving beyond compliance and into more outcome-driven thinking.

Adopting this mindset helps businesses stay focused on what matters most—even when rating frameworks may not fully capture the depth or complexity of their efforts. The key is to strike a balance: being responsive to external expectations while staying anchored in the substance of sustainability.