ESG

Understanding Sustainable Finance through ESG Indexes

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Understanding Sustainable Finance through ESG Indexes

Pablo COHEN

In this article, Pablo COHEN (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2024–2025) explores how sustainable finance is reshaping investment strategies through ESG indexes.

Introduction and Context

For decades, success was measured through financial indicators. Profits defined companies, and GDP per capita ranked nations. But as Robert F. Kennedy pointed out, GDP “measures air pollution and cigarette advertising… and ambulances to clear our highways of carnage.” It reflects economic activity, not societal well-being”.

Our actions shape the climate, ecosystems, and social outcomes — and those same forces now pose real risks to economies. France may have a far higher GDP per capita than El Salvador, but which emits more carbon per citizen? Which has a credible plan for net-zero by 2050? These questions are more relevant to long-term sustainability.

To enable meaningful comparisons, global bodies like the UN and EU have created frameworks and standards for sustainability reporting. Tools such as the EU Taxonomy, SFDR, and CSRD bring structure and consistency to ESG disclosures, helping investors assess corporate impact and redirect capital toward sustainable outcomes. If we don’t change what we measure, we won’t change what we prioritize — or what we build.

How ESG Indexes Work

We have an impact on the world, and the world has an impact on us. That’s the essence of double materiality — a foundational concept in sustainable finance. Sustainability risks, whether physical (like climate disasters) or transitional (like policy shifts), can directly affect financial performance through credit risk, operational disruption, legal exposure, and reputational damage.

Just as external events shape a company’s bottom line, financial decisions influence the environment and society. This two-way relationship is increasingly recognized by regulators and investors alike. Navigating it requires tools that make ESG performance measurable, comparable, and investable. This is where ESG indexes come into play.

ESG indexes allow investors to evaluate companies based on their sustainability profile. Depending on their design, they may exclude controversial sectors, highlight ESG leaders, track themes like clean energy, or align with climate targets such as the 1.5°C scenario. Examples include the MSCI ESG Leaders and Climate Paris Aligned Indexes, the S&P 500 ESG Index, FTSE4Good, and the Dow Jones Sustainability Index. These indexes are used not only as benchmarks, but as a basis for constructing portfolios that reflect long-term sustainability goals.

The growth of ESG indexes and sustainable funds has mirrored the rising demand for more responsible investment strategies. The following chart shows how both active and passive sustainable funds have surged over the past decade:

ESG Fund Growth Chart.
ESG Fund Growth Chart
Source: Morningstar Direct.

ESG in Practice and Market Performance

Index construction starts with exclusions — companies involved in fossil fuels, weapons, or major ESG controversies are filtered out. Then comes ESG scoring, based on data from corporate disclosures, regulatory filings, and third-party assessments. Companies are evaluated across environmental impact, social responsibility, and governance quality. This might include emissions intensity, labor practices, or board independence. Based on these scores, indexes select and weight constituents and are rebalanced periodically to reflect updated data.

The MSCI Climate Paris Aligned Index is designed to align with a 1.5°C scenario. It reduces both physical and transition risks by excluding fossil-fuel-intensive companies and emphasizing those with low emissions and strong climate governance. Compared to its parent index, the MSCI ACWI, it includes fewer companies but achieves a 50% reduction in portfolio carbon intensity. It’s a forward-looking tool that anticipates tightening regulations and evolving investor expectations.

Some ESG funds have even outperformed traditional benchmarks like the S&P 500. The chart below shows that several ESG funds delivered significantly higher year-to-date returns in early 2021:

ESG Fund performance compared to the S&P 500 index.
ESG Fund performance compared to the S&P 500 index
Source: S&P Global Market Intelligence.

This outperformance isn’t just recent. In 2019, sustainable large-blend index funds consistently beat the S&P 500 — with many delivering returns above 32%, as the following chart demonstrates:

Sustainable Funds Performance (year 2019).
Sustainable Funds 2019 Performance
Source: Morningstar Direct.

The rise of ESG is also visible in fund flows. More sustainable funds are being launched each year, and investor inflows have reached record levels — confirming that ESG isn’t just a trend, it’s a lasting shift in investment priorities.

Why should I be interested in this post?

As an ESSEC student preparing for a career in finance, understanding sustainable finance is no longer optional. ESG principles are reshaping how capital is allocated, how companies report, and how investment strategies are built. Whether you’re pursuing a role in banking, asset management, consulting, or entrepreneurship, knowledge of ESG frameworks and sustainable indexes will be essential for making informed, future-ready decisions in a rapidly changing financial landscape.

Related posts on the SimTrade blog

   ▶ Anant JAIN The Future Of CleanTech: Innovations Driving A Sustainable World And Their Financial Implications

   ▶ Anant JAIN Milton Friedman VS Archie B. Carroll On CSR

   ▶ Anant JAIN The Paris Agreement

   ▶ Anant JAIN The World 10 Most Sustainable Companies in 2021

   ▶ Anant JAIN Green Investments

   ▶ Anant JAIN United Nations Global Compact

Useful resources

Morgan Stanley (2023) Sustainable Funds Outperformed Peers in 2023

IEEFA ESG Investing: Steady Growth Amidst Adversity

Morgan Stanley (2024) Sustainable Funds Modestly Outperform in First Half of 2024

IEEFA ESG Funds Continue to Outperform

S&P Global Most ESG Funds Outperformed S&P 500 in Early 2021

Morningstar U.S. ESG Funds Outperformed Conventional Funds in 2019

The Economist American Sustainable Funds Outperform the Market

About the author

This article was written in April 2025 by Pablo COHEN (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2024–2025).

The G of ESG: The Critical Role of Governance

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Majd MAHRSI

In this article, Majd MAHRSI (ESSEC Business School, Global BBA Program, 2021-2025) delves into the critical role of governance in fostering sustainable business practices, particularly in emerging economies. Drawing from professional experiences such as an internship at DiliTrust, this article explains how strong governance frameworks can transform businesses and create new career opportunities.

ESG and Its Components

ESG (Environmental, Social, and Governance) is a framework used to evaluate a company’s sustainability practices and ethical commitments. It assesses corporate behavior across three dimensions:

  • Environmental (E): Focuses on a company’s impact on the environment, including energy use, waste management, and carbon emissions.
  • Social (S): Examines how a company interacts with its stakeholders, such as employees, customers, and communities, covering diversity, labor rights, and community relations.
  • Governance (G): Relates to a company’s internal systems for ethical decision-making, leadership accountability, and shareholder rights.

ESG has gained significant traction in recent years, with investors prioritizing companies that integrate sustainability into their core operations. This trend has driven the rise of Socially Responsible Investing (SRI), a strategy where investments are made based on a company’s ESG performance alongside financial returns. According to the Global Sustainable Investment Alliance (GSIA), global SRI assets surpassed $35 trillion in 2022, accounting for nearly 36% of all professionally managed assets. This rapid growth reflects the increasing demand for ethical and sustainable investment options, demonstrating how ESG principles are reshaping financial markets.

Further emphasizing the importance of ESG performance, Friede, Busch, and Bassen (2015) conducted a comprehensive meta-analysis of over 2,000 empirical studies, concluding that approximately 90% of the research found a non-negative relationship between ESG performance and financial performance, with the majority indicating a positive correlation. This underscores the financial benefits of robust governance practices as part of an ESG strategy.

Chart: Below is a graphical representation of the growth of Sustainable and Responsible Investing (SRI) assets in the United States from 1995 to 2018.

Growth of Sustainable and Responsible Investing (SRI) assets
Growth of Sustainable and Responsible Investing (SRI) Assets in the United States (1995–2018)
Source: Green America / US SIF Foundation.

Focus on Governance

Governance, the “G” in ESG, refers to the structures, principles, and processes that dictate how a company is controlled and directed. It encompasses:

  • Board Diversity and Independence: A diverse and independent board ensures balanced decision-making, reducing conflicts of interest.
  • Shareholder Rights: Empowering shareholders with voting rights and transparent reporting fosters accountability.
  • Executive Accountability: Ensuring executive compensation aligns with long-term company performance promotes ethical leadership.
  • Risk Management: Establishing frameworks for identifying and mitigating financial, operational, and ESG-related risks.
  • Transparency and Reporting: Clear and consistent disclosure of governance practices builds stakeholder trust.

According to Eccles, Ioannou, and Serafeim (2014), companies adopting sustainability policies, including strong governance practices, tend to outperform their peers in both stock market returns and accounting metrics, further emphasizing the financial value of ethical leadership.

Without robust governance, even the strongest environmental and social efforts can falter due to poor oversight and unethical practices.

Why Governance Matters in ESG

Good governance forms the foundation for a company’s long-term sustainability and financial stability. It ensures that leadership decisions align with stakeholder interests and corporate ethics.

Trust and Reputation

Strong governance builds stakeholder trust by promoting ethical decision-making and transparency. Companies with robust governance frameworks are better positioned to manage crises and maintain reputational integrity. In contrast, scandals like Enron and Wirecard have shown how governance failures can lead to significant financial and reputational damage.

Attraction of Investors

Investors increasingly view governance as a critical factor when evaluating a company’s sustainability and risk profile. Firms with strong governance, such as Unilever and Microsoft, consistently outperform peers in financial performance and stakeholder trust. According to a study published on Academia.edu, both companies have demonstrated strong financial performance due to their governance practices.

Key Elements of Strong Governance

The importance of effective governance is further highlighted by the OECD Principles of Corporate Governance, which provide a globally recognized framework for transparent and accountable corporate practices.

  • Board Diversity and Independence: Diverse and independent boards contribute to better strategic decision-making and accountability. SpringerLink confirms that diversity enhances decision-making quality.
  • Transparency and Reporting: Transparent reporting builds trust among investors and regulators. AB Academies highlights its importance for investor confidence.
  • Executive Accountability: Linking executive pay to long-term performance ensures leadership integrity. Research from AB Academies supports the link between performance and pay.
  • Risk Management: Effective risk management protects against both financial and reputational risks.
  • Ethical Practices: Implementing anti-corruption measures and maintaining compliance with laws.

Governance in Emerging Economies

In emerging economies, strong governance frameworks play a transformative role in fostering investor confidence and driving sustainable economic growth. Countries like Saudi Arabia, with Vision 2030, and South Africa, with its King IV Code of Governance, have implemented significant reforms emphasizing transparency, accountability, and ethical leadership to attract foreign investment and modernize corporate practices.

Family-owned businesses, prevalent in regions like the Middle East and Africa, often face unique governance challenges. Implementing independent boards and family charters can help professionalize these businesses, ensuring long-term stability.

Leveraging Technology for Governance

Technological tools, such as those provided by DiliTrust, are transforming governance practices. Platforms for secure document management, compliance tracking, and board meeting organization improve transparency and decision-making efficiency. During my internship at DiliTrust, I witnessed firsthand how these tools streamline governance processes, ensuring accountability across various operational levels.

Career Opportunities in Governance

Governance expertise can lead to several impactful career paths:

  • Independent Board Member: Certifications like those from the ITA in Tunisia equip professionals to serve on corporate boards, ensuring strategic oversight.
  • Governance Consulting: ESG consulting firms assist businesses in enhancing governance practices, ESG compliance, and sustainability reporting.
  • ESG Rating Specialist: Working in agencies that assess corporate governance and sustainability standards.
  • Risk and Compliance Management: Roles focusing on enforcing governance frameworks within financial institutions and multinational corporations.

Related Posts on the SimTrade Blog

   ▶ Majd MAHRSI My Internship Experience at DiliTrust

   ▶ Anant JAIN Environmental, Social & Governance (ESG) Criteria

   ▶ Nithisha CHALLA Activists in financial markets and the corporate world

   ▶ Anant JAIN MSCI ESG Ratings

Useful Resources

Saudi Arabia’s Vision 2030

South Africa’s King IV Code of Governance

DiliTrust Official Website

OECD Principles of Corporate Governance

Global Reporting Initiative

Institut Tunisien des Administrateurs (ITA)

SpringerLink on Board Diversity

AB Academies on Governance

Academia.edu on Unilever and Microsoft

Friede, G., Busch, T., & Bassen, A. (2015). ESG and financial performance: Aggregated evidence from more than 2,000 empirical studies. Journal of Sustainable Finance & Investment, 5(4), 210–233.

Eccles, R. G., Ioannou, I., & Serafeim, G. (2014). The impact of corporate sustainability on organizational processes and performance. Management Science, 60(11), 2835–2857.

About the Author

The article was written in January 2025 by Majd MAHRSI (ESSEC Business School, Global Bachelor in Business Administration (GBBA), 2021-2025).

MSCI ESG Ratings

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MSCI ESG Ratings

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about MSCI ESG Ratings.

Introduction

MSCI ESG Rating is a measure of a company’s commitment to environmental, social, and governance (ESG) criteria and socially responsible investments (SRI). The MSCI ESG rating focuses on a company’s exposure to financially relevant ESG risks. It applies a rule-based methodology to distinguish companies into industry leaders and laggards based on their exposure to ESG risks and their relative aptitude to manage those risks compared to their peers. The ESG Ratings are ranked from leader (AAA, AA) to average (A, BBB, BB) to laggard (B, CCC).

Rating companies on the basis of ESG dimensions enables socially conscious investors to screen potential investments according to their personal investment goals and values.

Environmental, social, and governance (ESG) criteria

ESG criteria constitute a framework that helps socially conscious investors screen potential investments that incorporate their personal values/agendas. The ESG criteria screen companies based on sound environmental practices, healthy social responsibilities and moral governance initiatives into their corporate policies and daily operations.

Socially responsible investing (SRI)

SRI is a type of investment that is categorized to be socially responsible due to the nature of the operation the company conducts. SRI is an investment that considers two aspects:1) social/environmental changes; 2) financial performance. In other words, socially responsible investors promote practices that they believe will lead to environmental benefits, consumer protection, racial/gender diversity, etc. Some socially responsible investors also do the opposite of investing by avoiding companies that negatively impact society, such as alcohol, tobacco, deforestation, pollution, etc.

How Do MSCI ESG Ratings Work?

Over the past decade, ESG investing has become more popular. In 2020, the US SIF: The Forum for Sustainable and Responsible Investment published that more than $17 trillion of professionally managed assets were held in sustainable assets (about one-third of all assets under management).

Data providers have created various scoring criteria to rank and access potential ESG investments. Besides MSCI, other financial firms have curated their own proprietary ESG scoring models, including Standard & Poors (S&P), Blackrock, and Russell Investments. As a result, socially responsible investors can make more informed decisions when screening companies, ETFs, or mutual funds to include in their portfolios.

Division of ESG into pillars

MSCI’s ratings segregate ESG into its three pillars: environment, social, and governance. Figure 1 below shows the main components of each pillar and the key issues of each component.

MSCI evaluate thousands of data points across 35 ESG Key Issues that focus on the junction between a company’s core business and the industry-specific issues that may create significant risks and opportunities for the company. All companies are automatically evaluated for Corporate Governance and Corporate Behavior.

Figure 1. MSCI ESG classification.
MSCI ESG Classification
Source: MSCI.

For example, in Figure 1, we take the example of a soft drink sub-industry (say Coca-Cola). In this scenario, the key issues for the environment and social pillar are highlighted. All the key issues mentioned for the governance pillar will be automatically considered for this industry (or any other industry).

Calculation of MSCI scores

When calculating the ESG scores for a company, MSCI rates each key issue from zero to ten. Zero indicates virtually no exposure, and ten represents very exposure to a particular ESG risk or opportunity.

MSCI also evaluates a company for its possible exposure to dubious business activities (e.g., gambling, weapons, tobacco, etc.). The data informing these scores are received from corporate filings, financial reports, and press releases. In addition to this, almost half of all data comes from hundreds of third-party media, academic institutions, non-government organizations (NGO), regulatory, and government sources.

Scores based on a company’s individual metrics are aggregated, weighted, and scaled to the relevant industry sector. Finally, an intuitive letter-based grade gets assigned to the company.

Assessment of MSCI scores

MSCI distinguishes its grades into three categories, mentioned below in descending order:

  • 1. Leader (grade AAA & AA) – this grade indicates that a company is leading its relative industry. The company is managing the most significant ESG risks and opportunities.
  • 2. Average (grade A, BBB & BB) – this grade indicates a company has an unexceptional or mixed track record of alleviating ESG risks and opportunities.
  • 3. Laggard (grade B or CCC) – this grade indicates that a company is lagging in its industry because of the high exposure to ESG risks and failure to mitigate them.

Figure 2. MSCI ESG Score board.
MSCI ESG Score board
Source: MSCI.

Example of MSCI ESG rating

The following case below is a real-life example of the MSCI ESG rating of Tesla, an electric vehicle producer. The company attained an overall grade of “A”, achieving the higher end of the “average” category.

When we look at the breakdown of this rating:

  • Tesla exceeds corporate governance and environmental risks, maintains a comparatively small carbon footprint, and utilizes green technologies.
  • The company scores an average grade for product quality and safety due to its past experiences of exploding batteries, undesirable crash test ratings, and accidents involving the car’s “autopilot” feature.
  • Tesla’s score is below-average for labor management practices. Tesla has been found to violate labor laws by blocking unionization. It has also repeatedly violated the National Labor Relations Act.

It is fascinating to note that the French auto parts maker, Valeo SA is the only company in the auto industry that earns a “leader” category grade from the MSCI ESG Ratings.

Related posts on the SimTrade blog

▶ Anant JAIN Environmental, Social & Governance (ESG) Criteria

▶ Anant JAIN Dow Jones Sustainability Index

▶ Anant JAIN Socially Responsible Investing

Useful resources

MSCI

MSCI Ratings Methodology

Tesla’s MSCI Rating

US SIF

About the author

The article was written in July 2021 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Environmental, Social & Governance (ESG) Criteria

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Environmental, Social & Governance (ESG) Criteria

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about Environmental, Social & Governance (ESG) criteria and its individual components.

Introduction

Environmental, social, and governance (ESG) criteria constitute a framework that helps socially conscious investors to screen potential investments which incorporate their personal values/agendas. The ESG criteria screen companies based on sound environmental practices, healthy social responsibilities and moral governance initiatives into their corporate policies and daily operations.

Environmental criteria analyze how an organization performs as an agent of nature. Social criteria examine how it manages relations with employees, suppliers, customers, and the communities where it operates. Governance criteria deal with a companies’ audits, taxation, and firm management (composition of boards, shareholder rights, etc.).

There has been a rise in social investing, particularly by the younger section of the potential investors such as millennials and Gen-Z. As a result, financial products (exchange-traded funds for example) following the ESG criteria appeared. According to the report from US SIF Foundation, “there has been an increase in the assets chosen by ESG criteria from $8.1 trillion in 2016 to $11.6 trillion in 2018.”

Components of ESG

ESG criteria provide investors insight into a company’s adherence (or lack of adherence) to ethical practices. The three components of ESG criteria are defined as follows:

Environmental Criteria

These criteria measure a company’s impact on the environment and its ability to alleviate potential risks that could harm the environment in the future. It includes issues such as a company’s energy use, waste, pollution, natural resource conservation, and treatment of animals.

Social Criteria

These criteria assess a company’s relations with other businesses, its standing in the local community, its commitment to diversity and incorporation among its workforce and board of directors, its charitable contributions, and whether it practices employee policies that foster health and safety.

Governance Criteria

These criteria assess a company’s internal processes, such as transparent accounting systems, executive compensation and board composition, and its relations with employees and stakeholders.

Types of ESG Criteria

The table below provides the different types of issues mentioned by the CFA institute for each criterion of the ESG component. They are as follows:

Table 1. ESG components.
ESG components
Source: MSCI.

Why is ESG Growth Accelerating?

Global sustainability challenges such as natural disasters, privacy and data security, and changes in demographics are introducing new risk factors for investors that may not have been seen previously. As companies face rising complexity at a global level, investors may re-evaluate traditional investment approaches. The demand for ESG criteria is increasing for the following reasons:

1. The world is transforming

Global issues, such as climate risk, increased regulatory pressures, social and demographic changes, and privacy concerns, represent new or increasing risks for investors. Companies face increasing complexities and more significant analysis if they do not adequately manage their ESG aspects.

2. A new era of investors

Millennial investors actively want to contribute back to society leading to rapid growth in ESG investment. In a 2018 survey, Bank of America Merrill Lynch said that “they could conservatively estimate $20 trillion of assets growth in U.S. ESG funds alone in the next two decades.”

3. Advancing technology

Advanced technology, including artificial intelligence (AI) and alternative data extraction techniques, reduces the dependency on voluntary disclosure from organizations. Machine learning and natural language processing are helping increase the timeliness and precision of data collection, interpretation and validation to deliver dynamic content and financially relevant ESG insights.

Working of ESG Criteria

To evaluate a company based on ESG criteria, financial investors look at a broad range of factors. They mainly follow any or all of the three criteria: Environment, Social, and Governance.

It is unlikely for a company to pass all the tests in every category. Therefore, investors need to prioritize their personal agendas that align with the ESG criteria. At a pragmatic level, investment firms that follow ESG criteria must also set priorities. For example, as of March 2020, Trillium Asset Management, with $2.8 billion under management, uses various ESG factors to help identify companies positioned for strong long-term performance. Trillium’s ESG criteria include avoiding companies with known exhibition to coal mining, nuclear power or weapons. It also avoids investing in companies with disputes related to workplace discrimination, corporate governance, and animal welfare, among other issues.

Conclusion

Earlier, only rating agencies specializing in sustainability paid attention to ESG criteria and similar concepts, with some dependency on information from the sector of the analyzed company. These agencies would collect information from the sustainability or CSR teams and provide their customers with their assessments.

In recent years, a rise in the interest of climate and social issues has led some of the most significant asset management companies to create specialized teams, developing internal methodologies to assign sustainable ratings. It is especially true with passive management funds (like Vanguard, State Street, BlackRock) and some active management funds.

As a result, in the year 2020, there was a striking increment in analysis and demand for information on environmental and social issues from investors.

Related posts on the SimTrade blog

▶ Anant JAIN Impact Investing

▶ Anant JAIN Socially Responsible Investing

▶ Anant JAIN MSCI ESG Ratings

Useful resources

The US SIF Foundation

The Bank of America Merrill Lynch Global Research Issues

The Trillium Asset Management

About the author

The article was written in July 2021 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).