When thought leaders bring a new idea, sometimes it’s worth paying attention. The author of Green Swans, John Elkington, calls the 2020s an exponential decade: “I don’t need to underscore the impact of the Covid-19 pandemic, but this is also an extraordinary time.” Investors have long been prone to describe once in a hundred-year events as ‘black Swans’ – usually as explanations of ‘unexpected’ poor performance.
But what if climate change, and the associated crisis in biodiversity, dooms us to a future packed with green swans?
Two of the most out-of-the-box thinkers, Judith Rodin and Saadia Madsbjerg, take up Elkington’s green Swans in their new book Making Money Moral. They assert that “Covid-19 has been the first such event, but it’s unlikely to be the last.” According to them, Covid has warned us of a need for greater preparedness for unexpected events – “the need to build capacity to prepare more effectively” and “rebound more quickly.” The pair, leaders of the Rockefeller foundation, suggest the addition of the letter R to ESG to create ESGR, because “resilience is rapidly making its way into corporate and investment considerations”.
This perspective is certainly being taken up by international bodies and the development finance institutions. Perhaps unsurprisingly, it is in developing countries that the greatest disruption to economies and businesses has occurred. These players, being in the front line there, can see the importance of building back with more resilience.
In an excellent paper, the OECD argues: “The costs of a crisis may far outweigh incremental investment in resilience.” As they say: "The pandemic is a reminder of our own fragility, an uncomfortable thought perhaps, but… preparedness and resilience are a silver lining to this crisis.”
The catalogue of business disruption is worth looking at closely. Of course, much of what the OECD argues centres on the need for better physical infrastructure, but – in an echo of the talk coming out of the Biden administration – the paper also notes: “the crisis has brought renewed focus on social or ‘soft’ infrastructure.” Covid has emphasised disparities in gender, ethnicity and income.
This is an observation that the World Economic Forum concurs with in its thought piece resilience investing. “Institutional investors are now, more than ever, seeking to strengthen the ‘S’ in ESG metrics, a gap that can be met by investments to prevent fragile situations from spiralling into crisis and to pave the road towards a sustainable economic recovery.”
They note the considerable rise in social bond issuance in response to the pandemic; an increase of over 350% in 2020 over 2019.
The OECD paper also points out the much broader effects which investors have become aware of. For example, it notes the considerable strain put on contractual arrangements. The last year saw an extraordinary number of invocations of force majeure clauses.
Consultants are telling us that the efficiency obsession of the last 20+ years is over. Resilience is the new watchword.
It also points out that “Covid-19 has demonstrated the fragility of some financing structures; especially where high leverage has meant that projects are not resilient to shocks”. This was particularly true of special purpose vehicles where lenders have limited or no recourse to sponsors. Going forward, the OECD argues financial covenants (using borrowing restrictions and financial ratios et cetera) will be more important.
These areas need attention because repeated disruption is inevitable. Climate change and the biodiversity crisis, spawning numerous green swans, make such considerations more important in the future for businesses and investors. In The Resilience Imperative – succeeding in uncertain times, McKinsey warns: "Catastrophic events will grow more frequent but less predictable. They will unfold faster but in more varied ways." They show some very worrying graphs worth looking at. The most frightening is the one showing the dramatic rise in the frequency of natural disasters. It looks like a quintupling in the last 40 years. Given recent freak weather events in the US, Canada (heat) and western Europe (floods) and other extremes globally, that doesn’t look outlandish.
As they say, “The changing climate presents structural shifts to companies’ risk-return profiles, which will accelerate non-linearly,” adding: “They must be able not only to withstand unpredictable threat or change but to emerge stronger. In short, they need to be resilient.”
This has real implications for investors. For the reasons cited above, Development Finance Institutions are embracing this new thinking. Amal-Lee Amin, Director of Climate Change and Value Creation Strategies at CDC Group, the UK’s publicly-owned impact investor, told me: “Climate change poses increasingly high probability risks and is a growing concern to investors. Integrating physical climate risk assessment and effective resilience planning must become a core part of our ESG toolkit and we urgently need to build capabilities to deliver this.”
Apart from the usual consultant speak about dynamic management systems et cetera, McKinsey also argues for something new: “Companies need to navigate concerns for their immediate bottom line.” This can be done by ‘add on’ policies, it says (“boxes of supplies, emergency generators, backup servers”); and embracing ‘trade-off’ approaches (“capital buffers, stocks of goods, and overstaffed call centres all fall in this category. These are considered explicit trade-offs between resilience and other parts of the system, often returns or productivity”).
Pause a moment. Consultants are telling us that the efficiency obsession of the last 20+ years is over. Resilience is the new watchword.
This new idea is being embraced in the private equity world. Bain & Company recently surveyed general partners in the Asia-Pacific region and found that 60% of them say they’re “willing to invest at least 5% of a portfolio company’s short-term profit to build long-term resilience."
For some of the largest public pension bodies this trade-off concept is now fully understood. Canada’s Public Sector Pension Investment Board said climate change was one of several long-term structural trends that will “likely have a material impact on investment risks and returns, across different sectors, geographies and asset classes”. It added: “This entails actively considering climate resilience at the portfolio construction level, factoring climate risks into investment decisions.”
Of course, for many responsible investors ‘resilience’ has always been there as a factor. Roger Lewis, Head of ESG at River and Mercantile Group told me: “For climate, resilience is incorporated and integral in ESG… ‘resilience’ can already be achieved by robust ESG integration to investment processes.” And according to the latest SRI & Performance Study conducted by French asset manager La Financière de l'Echiquier, high scoring companies proved much more resilient during the pandemic. During 2020, the portfolio with the best ESG scores posted a 15% return, outperforming the portfolio with the worst ESG scores by a factor of 68.
I’m inclined to agree with Cindy Rose, Head of Responsible Capitalism at Majedie Asset Management, who told me: “Resiliency will become king in a world where uncertainties are growing in weather and earth systems.”
Fool me once, shame on you; fool me twice, shame on me. It’s time for ESGR.
Christopher Walker is a writer on business and politics. He sat for several years on the asset allocation committee of a major asset manager.