Institutional Shareholder Services (ISS) recently introduced more methodology updates to its main ESG rating system, the ISS QualityScore (ISSQS). The system grades companies across Environmental, Social, and Governance pillars relative to their industry and region and based on hundreds of data points. The latest round of changes to the data-driven scoring methodology focuses specifically on the Governance pillar of the QualityScore, and ISS has dubbed it “the most extensive methodology enhancement” yet.

In an October 31 announcement, ISS noted that the changes affect a total of 75 factors, 26 of which impact U.S.-based organizations. Further, almost every sub-pillar of the Governance Score is affected, including Board Structure, Compensation, and Audit & Risk Oversight. The Shareholder Rights sub-pillar is the lone area that has been left untouched.

While some of the new factors do not impact scores, those that do have an immediate influence your ratings include:

• Ethnic diversity on the Board
• Existence of anti-pledging policy
• Number and value of pledge shares
• Overall quantitative concern level for the CEO’s pay for performance evaluation (low, medium, or high, based on ISS’s internal pay for performance model)

In the coming weeks, ISS will publish updated scores for all the companies it rates, and the new ratings will reflect these additional requirements.

If your score drops, take action to get it back on track

Companies that have not verified data, submitted changes, or disclosed new information on the newly scored factors may find themselves with a lower GQS score when the new ratings are published. In this case, you can use the data verification and feedback process to provide additional details that can help remedy your score. Following the publication of the new scores, simply log into the Governance Analytics portal and navigate to the “QualityScore Data Verification” portal to make your submissions.

Keep in mind that while some new factors are straightforward, others are a bit more complex. For example, on compensation related factors including the CEO’s pay for performance evaluation, ISS conducts its own assessment of executive pay using an internal pay for performance model. The model yields ‘low’, ‘medium,’ and ‘high’ concern levels based on a company’s three-year financial performance, the CEO’s pay compared to peers, and total shareholder returns. Companies that are outliers in the pay for performance screener will likely not receive any credit under this factor, hurting their overall GQS.

But a medium or high concern level for this factor could have even greater implications for a company considering the new SEC pay versus performance rules coming into effect in 2023. Now is the time to begin thinking about how to incentivize executives according to performance as opposed to over-relying on time-based incentives and to ensure your practices are on par with those of your peers. These actions can lead to a better score on this factor in the future as well as prepare you for forthcoming regulations.

Be aware of other new factors that shareholders may consider

While the handful of factors that directly affect your new ratings are the most critical to address right away, you should also be aware of several additional new factors that may be considered by your shareholders, even if they won’t be scored yet. ISS has a track record of introducing factors initially as “unscored,” and then months or years later, switching them to scored. For example, in 2016, three new compensation-related factors debuted as unscored for European companies, but ISS fully integrated them into QualityScore the following year.

In this latest round of methodology updates, the noteworthy non-scored factors fall into several of the Governance sub-pillars:

• Compensation: While most compensation related factors are data points driven by ISS’s internal pay for performance model, one new non-scored factor ties information security to executive pay:
  • What is the disclosure level of information security-related performance measures for the executive short-term or any executive long-term incentive plan? (Q443)

• Board Structure: In this sub-pillar, the only new non-scored factor will likely be used to expand the acceptable diversity threshold a board should have, whether for the U.S. Benchmark policy or for other customized proxy voting policies:
  • Are there LGBTQ+ directors on the board? (Q427)

• Audit & Risk Oversight: Ten new non-scored factors in this sub-pillar appear to be anticipating proposed rules by the SEC on human capital management, climate, and cyber security. They include:
  • How many directors have climate skills? (Q438)Does the company disclose its third-party information security risks? (Q441)
  • What percentage of the committee responsible for human capital management is independent? (Q447)

Data on all these new factors will be available to all subscribers of the ISS data platform, and they could eventually become scored, especially as new SEC regulations come into effect. In the meantime, it is possible that information and data provided will influence ISS’s shareholder and management proposal voting recommendations. Your answers may also be leveraged by certain institutional shareholders for proxy voting decisions.

Give your ISS QualityScore the attention it deserves

As the oldest and one of the most prominent ISS ESG ratings, the Governance QualityScore is available on every company’s profile at Yahoo! Finance and is displayed on the front page of ISS’s proxy analysis, available for all investors to view. Subscribers use the relative ratings, given in decile scores, to screen companies for ESG risk and make informed decisions on their portfolio firms. Companies with an ISSQS of 1, for example, are in the first decile, meaning they have strong ESG practices and low risk. On the other end of the scoring spectrum, companies with an ISSQS of 10 have high governance risk.

The ISSQS collects publicly available information from SEC filings, corporate websites, and sustainability reports to grade corporations on their ESG practices. To ensure accurate ratings, it’s important to provide quality disclosures in these communications as well as to leverage the ISS feedback process to submit information about ESG progress.

Have questions about the latest ISSQS methodology changes, the data verification process, or how to improve your scores? Reach out today. And make sure you get the ESG ratings you’ve earned.

Source: ISS ESG Releases Extensive Methodology Updates for Governance QualityScore (October 31^st, 2022)