State Street R-Factor Explained: ESG Management Ratings

What Is the State Street R-Factor?

The State Street R-Factor is a scoring system developed by financial holding company State Street Corporation’s investment management arm. It rates public companies based on their management of environmental, social, and governance (ESG) issues. The R-Factor is customizable to specific sectors like pharmaceuticals, retail, and materials.

State Street Global Advisors (SSGA) has said that it is going to begin penalizing the directors of big companies that consistently underperform on its R-Factor system by using its considerable shareholder voting clout. Its aim is to help companies recognize ESG shortfalls and to encourage improvements. The “R” stands for responsibility.

How the State Street R-Factor Works

Corporate performance on environmental, social, and governance issues, often referred to as ESG, has become of increasing interest to financial advisory firms.

So, State Street Global Advisors, one of the world’s largest investment management companies, decided to build a process to evaluate a company’s performance related to financially material and sector-specific ESG challenges.

An Introduction to the R-Factor

In a letter to board members in February 2020 that also appeared on the Harvard Law School Forum on Corporate Governance website, State Street Global Advisors CEO Cyrus Taraporevala said shareholder value “is increasingly being driven by issues such as climate change, labor practices, and consumer product safety. We believe that addressing material ESG issues is good business practice and essential to a company’s long-term financial performance—a matter of value, not values.”

He said State Street Global Advisors (SSGA) will “take appropriate voting action” against board members if they can’t explain how they plan to improve their scores.

“Ultimately, we have a fiduciary responsibility to our clients to maximize the probability of attractive long-term returns — and will never hesitate to use our voice and vote to deliver better performance for them,” said Cyrus Taraporevala, SSGA chief executive, in the letter. “This is why we are so focused on financially material ESG issues.”

The companies being scrutinized are listed on exchanges in the U.S., Japan, U.K., Australia, Germany, and France.

Overview of State Street Global Advisors (SSGA)

Formed in 1978, SSGA is one of the world’s largest index fund providers. It managed assets worth $3.5 trillion as of mid-2021. Its stewardship activities have focused on gender diversity and climate change over the last few years.

It’s also the company that commissioned the famous “Fearless Girl” bronze sculpture in New York’s financial district a year after launching the gender diversity SHE ETF.

“We believe a company’s ESG score will soon effectively be as important as its credit rating,” said Taraporevala in his letter to board members.

How the R-Factor Is Measured

SSGA says its proprietary ESG scoring system measures the performance of a company’s operations and governance as it relates to financially material ESG challenges, and provides a roadmap to firms looking to improve.

The scoring system is meant to fill the need for a standardized, transparent method to assess the long-term sustainability of companies.

The R-Factor has two components: ESG and corporate governance.

The system sources data from four different providers – Sustainalytics, ISS-ESG (formerly Oekom Research), Vigeo-EIRIS, and ISS- Governance – to improve overall coverage and remove biases inherent in existing scoring methodologies. 

Of all the data collected, only parameters that have demonstrated links to sustainable long-term value creation are used. A framework developed by a non-profit called the Sustainability Accounting Standards Board (SASB) is used to identify what metrics are financially material for each industry. The SASB Materiality Map includes 26 issues under categories including environment, social capital, human capital, business model, innovation and leadership, and governance issues.

Relevant country-level corporate governance codes are also incorporated to provide market specificity.

“We’ve dedicated significant time and resources to developing R-Factor because of our belief in the value of ESG integration across investment strategies,” said Rakhi Kumar, head of ESG Investments and Asset Stewardship at SSGA. “By sharing R-Factor scores and educational ESG resources with portfolio companies, and developing investment solutions powered by the system, we are enabling investors and companies to help us build more sustainable capital markets for the future.”