A 2023 London event brought together Thinking Ahead Institute experts and members to consider practical approaches to developing coherent and compelling narratives on where next for sustainability and ESG in support of long-term organisational strategies.
In the first session, delegates considered approaches to ‘rightsizing’ ESG and deploying horizon scanning to better manage systemic risks and to more readily identify ESG opportunities. Read about the first discussion, and related insight here. The second half of the event programme, and this insight, is based on the outputs led by Thinking Ahead Institute researcher Isabella Martin. We will consider the building blocks or ‘bricks’ to “hold the edifice of ESG upright” into the future, specifically:
- Strong foundations – 12 bricks for a strong ESG future
- Four ecosystem bricks
- Four theory and thinking bricks
- Four infrastructure/enabler bricks.
Strong foundations – 12 bricks for a strong ESG future
Martin opened the session explaining how growth factors for the future of ESG can be segmented into three main buckets: ecosystem (which includes various components of the system), theory and thinking (referring to underlying theoretical frameworks) and the infrastructure/enablers (which focuses on the influence and importance of global coalitions of leading financial institutions, global standards, and climate solutions).
Many of these represent spheres for fundamental changes to investment and capital markets, the challenges around which will centre on achieving meaningful and optimal collaboration, with Martin highlighting how, “this is the difference between fuel and friction; when organisations meet any resistance, they often focus on adding fuel, but they also need to subtract the friction.”
Martin added how this is particularly relevant for boards, as some may be slow to change their orientation from accepted practices and fiduciary principles to newer practices better suited to a future characterised by systemic, synchronised, and interconnected risks and opportunities.
Four ecosystem bricks
Purpose-driven companies
Martin highlighted how we are seeing a widening of purpose as organisations place more emphasis on their social license to operate, both doing the right thing, and being seen to do the right thing.
‘Double materiality’, which is part of the requirements of multiple climate and sustainability frameworks including the EU Taxonomy, takes the financial concept of materiality a step further. First, it considers the climate related or ESG impacts that can be material on the company (single or financial materiality) and second, the impacts of the company on climate and sustainability, known as ‘impact materiality’, to form ‘double materiality’.
Within the context of double materiality, purpose-driven companies are a key strategic component of the ecosystem, and this pressure is only increasing with heightened stakeholder and societal scrutiny.
Diversity, equity, and inclusion
An increase in the prominence of systemic risk – itself a ‘brick’ of the ecosystem infrastructure – means it is crucial organisations place more focus on diverse people, talent, and teams to deal with this risk. WTW analysis in a 2023 white paper Diversity in the asset management industry: On the right track, but at the wrong pace, continues to make the case for greater diversity, with investment teams in the top quartile of gender diversity outperforming those in the bottom quartile by 0.45% per annum.
In addition to using diverse teams and skill sets to address global systemic risk areas over the next 10 years, the asset management industry needs collective action, collective solutions, and systems leadership, with collaboration representing a further ecosystem brick.
Four theory and thinking bricks
Systems theory and evolving economic theory
Beyond collaboration, the asset management industry is under pressure to migrate from modern portfolio theory to modern systems theory, which understands the world by looking at the interconnectedness of systems over time and responds to the expected increasing synchronicity of systemic risk.
Existing models, including some climate models, don’t adequately cover these risks. This is because they don’t consider tipping points and path dependency. This means the industry needs a better understanding of the enablers of governance, culture, and mindsets, in addition to total portfolio approaches to investment strategy to navigate systemic risk and position for opportunity.
A strong ESG future will also depend on increased systems thinking that extends across the investment ecosystem and its multiple models: the investment model, business model, change, system, and people models.
Universal ownership theory
In a new regime where large asset owners are universal owners, they recognise the need to evolve their economic theory in light of the impossibility of diversifying away from systemic risks.
In terms of which ESG investing bricks are in most need of industry collaboration, delegates suggested systems thinking and universal ownership (though there was recognition this may appeal to only a ‘willing’ segment of the market and perhaps not, for example, amongst ‘free riders’).
The universal ownership discussion is likely to become increasingly “noisy” in the coming years, with the Thinking Ahead Institute pointing to moves by the likes of The Shareholder Commons in the US, which advocates for an economic system in which companies and investors are expected to forgo profits that would come from depleting the common resources upon which all companies rely, and instead to focus on profits from authentic value creation.
Universal ownership thinking recognises that success depends on adding sustainable value for stakeholders. This value may be added by considering alternative economic theories. These alternative models include Kate Raworth’s ‘Doughnut Economics’ which describes the ‘safe and just space for humanity’ as lying between two concentric rings: a social foundation that meets the needs of everyone in society, and an ecological ceiling ensuring humanity does not collectively overshoot the planetary boundaries that make Earth’s life-supporting systems sustainable.
Greater dominance of these models would also likely support the transition away from ‘ESG’ vocabulary to ‘sustainability’, representing the fourth ‘brick’ in the theory and thinking set.
Four infrastructure/enabler bricks
The four infrastructure bricks centre on:
- The International Sustainability Standards Board (ISSB) which issued its inaugural sustainability standards: General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and Climate-related Disclosures (IFRS S2) as part of its drive to deliver a comprehensive global baseline of sustainability-related disclosure standards. While this is seen by members as a game-changer and there is great anticipation this will lead to convergence and simplification, there were concerns the endeavour could take “decades to land”.
- The Glasgow Financial Alliance for Net Zero (GFANZ) – an umbrella body for more than 650 financial institutions with net zero commitments – announced last year that investors could credibly support the climate transition by allocating their capital to solutions, climate-aligned companies and assets, or companies and assets with a serious commitment to transition. They could also invest in the timely phase-out of polluting assets, such as coal plants. There were concerns regarding the politicisation of activities in this space that could demand a reframing of GFANZ if it’s wider aims are to be met.
- Climate and ESG indices – while this could represent part of the infrastructure that holds firm the future of ESG, the industry will need to make moves towards greater integration and more fundamental restructuring so investors can look for more opportunities. There were also wider expectations on the role of private capital in achieving net zero.
- Transition finance and blended finance – delegates felt that blended finance – the strategic use of public and private finance towards sustainable development in developing economies – represented challenges around driving capital into opportunities. There was a belief institutional asset allocation should drive this, for example into emerging markets and movements around risk-sharing between investors and governments, but with higher standards than, for example, UK historical public private partnerships. However, there was recognition the public purse may not stretch to include this in the near future at least.
Systems theory and evolving economic theory
Collaboration is key for a strong future for ESG. This is about prioritising high quality partnerships, and improving the structural integrity of existing collaborations so that the investment industry can support aligned joint ventures focused on addressing the most pressing systemic risks.
While recognising there are limits to its agency, the attendees felt the investment industry could do more to support the transition to wider-purpose sustainability. Because if the finance and investment industries won’t think about how we address systemic risk, to better manage ESG risks and opportunities, who else will?
Read the first FOESG event insight here.
Listen to Luba Nikulina, Chief Strategy Officer at IFM Investors, and Roger Urwin, Global Head of Investment Content at WTW and Co-founder of the Institute on the importance of rightsizing your sustainability commitments and how all of this is relevant for investment organisations today.
To understand more about total portfolio approach or discover how Thinking Ahead Institute can help you with right-sizing and horizon-scanning projects, get in touch.