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The State of ESG 2.0: from incremental to systemic change

A new report translates the difficult questions we have on sustainability into suggested investment changes

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Well done on carving out a moment to read this, assuming you’re a sustainable finance professional. The pace and volume of work is extraordinary right now, with enormous regulatory changes afoot and client demand like never before. We have seen an incredible rise in ESG investing this past year, something I and many others could only dream of 10 years ago when I was working at PRI and the industry was in its relative infancy. 

The grit in the oyster is that this growth has been accompanied by a growing chorus of dissent, questioning where the rise in sustainability disclosure and ‘green-wishing’ is really headed – and whether it is commensurate with the sweeping changes society is increasingly calling for, from climate change to social inequality. Recent critiques from ‘reformed’ ESG professionals Tariq Fancy, Ken Pucker and Auden Schendler are asking difficult questions as to whether the means are leading us to the ends. Finance is, after all, a means to an end; and ESG a tool within those means – not the end in itself. 

What does it mean to have endless growth in a world with finite resources? And what does this imply for – or demand of – the financial system? Many within the sector, myself included, are grappling with the paradigm shift needed if we are to live within planetary boundaries and address societal needs equitably. This shift calls in to question the structural impact of investors’ business models and approaches to asset allocation. What the sector now needs is to translate these questions into meaningful action. 

Guidance to address systemic risks, sustainably 

Predistribution Initiative’s ESG 2.0: Measuring & Managing Investor Risks Beyond the Enterprise-level tackles these systemic issues head on, providing a detailed analysis of problematic investment trends in recent years. The paper highlights the inherent contradictions of more ‘traditional’ ESG approaches to sustainable investing, applied commonly at the underlying enterprise or asset level, and the structural impact of asset allocation decisions at the level of the financial institution itself, particularly in relation to global economic inequality, increasingly recognised as posing systematic risk. 

The report says: “In practice, the negative impacts of weak capital structures are typically being addressed piecemeal through company-by-company interventions that focus on their operations, like a game of whack-a-mole; but the key roots of the problems — the investment structures themselves — are left unaddressed.”

Rather than simply raise uncomfortable questions, the paper proposes 11 broad preliminary solutions accompanied by many more practical ideas. All are proposed through the lens of how ‘understanding how allocations to high-risk asset classes may ultimately undermine long-term return goals can help fiduciaries fulfil their commitments to beneficiaries and manage accordingly.’ The preliminary solutions – all intended for future debate and workshopping with asset allocators – are wide-ranging. For example, in recognition that the risk/return allocation is no longer what it was, suggestions include to reconsider asset allocation by de-consolidating cash flows and taking a less ‘bucketed’ approach, allocating less to traditional fixed income and high-risk asset classes and more to emerging and regenerative asset classes in the middle of the risk-return spectrum, ranging from permanent capital vehicles to revenue-based financial models. Other solutions are more inward facing, such as ensuring diversity of thought and experience amongst trustees and leadership, including in relation to ESG integration and systematic risk management, and incentivising them accordingly. Others relate to engagement with fund managers, such as measuring and managing fund manager political spend in recognition of corporate political capture. 

This work, coupled with a forthcoming website from the Impact Management Project’s Structured Network  - an effort by the leading global voluntary standards and disclosure frameworks to explain how they can be used together – underscores that this is a timely opportunity for more asset allocators to enter the ‘systemic change’ fray. No individual investor can change the system, but there are many actions that financial institutions (and more specifically, individuals within those institutions) can take. These include engaging with collaborative efforts, which can provide a safe space for discussion and learning (see also The Investment Integration Project, Climate Safe Lending Network). 

Time to step forward

Ultimately, though, there is no time to lose in taking action – however tentative and imperfect those steps might feel. The financial industry is a key enabler of the transitions needed. And it is increasingly under scrutiny itself. The recent Edelman Trust Barometer specific report on the financial sector points to a significant drop in trust in financial institutions in the past year across all financial services. This is from a low position to begin with, as one of the least trusted of all business sectors, despite gradual gains year-on-year following the 2008 financial crisis. Most worryingly, perhaps, is the growth in the past year between the perception in trust of ‘the informed’ and the general public, the latter of which has shockingly low levels of trust in financial services. Even sustainability professionals place institutional investors near the bottom of the list when asked which sectors are demonstrating sustainability leadership. 

These developments have all informed the World Benchmarking Alliance’s Financial System Transformation Benchmark, the draft methodology for which will be published in June. The benchmark’s aim is to illustrate the progress made by influential financial institutions (400 globally) in supporting systems change towards a sustainable future, by assessing and ranking the steps taken- and disclosed. In developing the benchmark methodology, we are working with a number of our Allies, ranging from the Predistribution Initiative to structured network partners of the Impact Management Project, including UNEP FI, the PRI and the Principles for Sustainable Insurance. 

Our current environmental trajectory poses an existential threat to planetary health and humanity, and we’re far from being all in this together, as the pandemic has so cruelly exacerbated. As a key enabler of economic activity, the financial industry – and sustainable finance professionals in it – are rightly reviewing their own contribution. There is a huge opportunity to act, and to better articulate to the general public what (positive) impact finance can have and the steps the industry is taking – individually and collectively – to meet that challenge. This is (y)our moment. How are you going to use it? 


Emilie Goodall is Financial System Lead at the World Benchmarking Alliance (WBA) and sits on the Advisory Board for the Predistribution Initiative ESG 2.0 paper. Predistribution Initiative is a formal Ally of the WBA, as is the Impact Management Project, of which WBA is a structured network partner.


This is part of a series of RI articles on The State of ESG.

Emilie will be speaking at the RI Europe conference on The State of ESG panel on Monday June 14.

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