While the future of environmental, social and governance (ESG) as a concept is the subject of much debate, systemic risks, such as climate change, geopolitical tensions, and supply chain disruptions are rising in their size and synchronicity. A 2023 London event brought together Thinking Ahead Institute experts and members to develop coherent and compelling narratives on where next for sustainability and ESG. These are needed to support long-term organisational strategies, in light of the growing risks.
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.
Specifically, we examined:
- Sentiments on the future of ESG
- Potential pathways for ESG/sustainability
- Horizon scanning and the future of ESG
- Rightsizing and the future of ESG.
Sentiments on the future of ESG
Delegates were asked to share a single word or phrase they felt best describes the future of ESG. They responded with a breadth of sentiments:
- Precarious, ambiguous, divisive, polarising, bleak
- Hopeful, positive, exciting, impactful
- Evolving, needs to get real, needs redefining, quixotic, puzzling
- Unavoidable, necessary, unstoppable, transformational.
The diversity of views itself perhaps indicates an uncertain future for ESG, though arguably this was more for the ‘ESG’ term and less for the concept of sustainability more broadly. There was a feeling, amongst some delegates, that the future of what we understand to be ‘ESG’ today will not be termed as such tomorrow. What we define as ESG strategies today may simply be redefined as ‘good investing’ or ‘sustainability’ into the future.
The rest of the event programme was designed to help delegates work through today’s ambiguities over ESG, and to best understand how asset owners and asset managers can equip themselves to thrive in the face of an uncertain future.
Potential pathways for ESG/sustainability
Roger Urwin, Thinking Ahead Institute Co-founder, set the scene, considering how the future narrative around ESG will evolve through a number of overlapping strands. Therefore, demanding that we aggregate and analyse interacting trends, piecing the practical realities of ESG and its impact together from multiple facets.
These ESG strands include evolving regulation and the increasing volume of ESG data. While ESG metrics appear to be getting broader and wider, this data is not necessarily decision useful.
A further strand introduces questions around how the industry attracts the talent it requires, calling on interdisciplinary experts and innovative and practical thinking to solve this and other strategic quandaries.
That is why horizon scanning is crucial and involves collaboration across disciplines to widen perspectives with Urwin making the point, “all of us are smarter than any of us.” As for the time frame over which to scan the horizon, it was suggested that five to ten years into the future represented a sweet spot.
Urwin went on to highlight how ESG is clearly in a state of transition, with modern portfolio theory now migrating to systems theory. However, there remains a tricky balancing act between the forces of ‘solid’ finance and the potentially ‘softer’ real-world impacts ESG seeks to capture and present as value.
It was also noted how ESG is proceeding at various speeds, with the US likely staying in a “slower lane.” The SEC’s long-awaited climate proposal is still yet to materialise, meanwhile, global regulation is exerting a strong influence over the direction of travel, compounded by the recent issue by the International Sustainability Standards Board (ISSB) of its inaugural sustainability standards1.
Urwin pointed also to the global transition to an era not only defined by net zero, but also of wider and longer purpose, where governance and technology and cultural shifts will combine to deliver competitive edge. And with success defined increasingly around the extent to which stakeholders receive sustainable value. This future framed by wider purpose will see new measurement paradigms emerge.
Similar to the globalisation transition of the recent past, the sustainability transition will also depend on the excellence of organisations in the following key areas:
- 3D frameworks – strategies and mandates that convincingly balance risk, return and impact
- Innovative research, thought leadership and effective engagement on ESG and impact
- Leverage of talent and brand to connect and engage key stakeholders
- Culture that rewards purpose and sustainability thinking.
This is all part of the pivot away from strategic asset allocation constructs, which befitted a world with fewer known complex issues, where creating benchmarks and allocating to managers to beat those benchmarks was an appropriate investment management strategy. These traditional strategies are now less effective in a landscape characterised by complex and interconnected systemic risk.
Funds are increasingly using mandates they can evolve to ensure they remain aligned with their values, and this represents an elevation to more dynamic and goal-centred approaches. These strategies will be driven by total portfolio approach (TPA) principles that connect ESG governance and competition for capital among all investment opportunities, rather than simply filling asset class buckets. This is something of a quiet revolution, where culture and behavioural change can deliver greater value than outmoded, older models. As ESG and climate lend total portfolio approaches greater impetus, we can expect the volume of that quiet revolution to grow louder.
The edge in total portfolio approaches over traditional thinking is potentially massive and, in most situations, the fulfilment of that potential will depend more on meeting governance, behavioural and cultural challenges than the mastery of the technicalities.
Horizon scanning and the future of ESG
Having delineated a new era of investing, with its opportunities and challenges, Thinking Ahead researcher Andrea Caloisi moved the focus onto horizon scanning.
Horizon scanning is the systematic analysis of potential threats and opportunities, and likely future developments, enabling you to catch a glimpse of the future by observing fragments embedded in the present. Horizon scanning is not about predicting the future, rather its value is in changing mindsets, challenging assumptions and providing alternative options for action.
Caloisi set out the infrastructure and ecosystem ‘pillars’ to consider when scanning the ESG horizon.
Infrastructure pillars include:
- Measurement | when we think about measurement, we consider the historical predominance of alpha (the return relative to a benchmark) for assessing performance and comparisons between peers. Thinking Ahead Institute believes TPA strategies can play a key role in balancing-out the supremacy of alpha with a balanced scorecard of other factors such as resilience
- Data | though data might represent the backbone of the entire ESG structure, data can be uneven, weak, and “messy” when it comes to sustainability, often not helping with decision-making. Here too, TPA and balanced scorecards can help us move up from data to information, and hopefully on to insight and wisdom
- Stewardship | in its current form, stewardship is far from its full potential; it is largely under-resourced and uncoordinated, and it often solely manifests via company-level engagement, resulting in only limited influence. The Thinking Ahead Institute believes the systems thinking embodied by TPA could make a significant difference here too.
Ecosystem pillars include:
- Politicisation | how political polarisation can enter the fabric of the investment propositions, eroding the efforts to cope with an increasingly complex environment
- Regional regulatory models | there is considerable variation across different jurisdictions, generating potentially onerous obligations
- Net-zero commitments | these are global in nature and scale but local in the allocation of resources to address the requirements, with a lack of strategy and implementation, again issues that might be addressed by holistic, long-term TPA investment strategies.
So, what do Thinking Ahead Institute members feel about the future state of these six ESG pillars? Following in the footsteps of a working group of Thinking Ahead Institute members, event delegates were presented with a scorecard to indicate how closely they expected the future of the six pillars to align between a choice of two alternate versions of the future. The less-desirable and more-desirable future states for each of the pillars were as follows:
| Less-desirable future state | More-desirable future state | |
| Measurement | Success in investment industry narrowly focused on shorter-term financial return, lacking a holistic approach to non-financial aspects | Success in the investment industry is assessed qualitatively and quantitively using balanced scorecard with non-financial data |
| Data | Data proliferates but with weak systematisation. The availability of data gives illusion of progress without substantial impact | Data continues to have gaps, but better strategies for dealing with those gaps emerge, and data becomes decision-useful |
| Stewardship | The stewardship model remains weak as the industry fails to coalesce. Stewardship practices remain ad-hoc with minor focus on system-level change | A stronger stewardship model comes together with a system-level focus with senior figures influential |
| Politicisation | Industry faces increasing political pressure and seeks to operate under the political radar, narrowing its attention on sustainability factors | Industry operates within the political sphere based on clear sense of purpose and fiduciary responsibility |
| Regional model | Regional priorities prevail, undermining regulatory uniformity and impeding faster progress | The investment industry becomes better aligned in its regulatory framework with EU and US differences diminishing |
| Net zero investing | The industry becomes overwhelmed by the multiple, complex challenges of net zero, falling behind the expected pace of transition | Industry proficient in net zero investing with full integration into processes and behaviours |
Measurement | views settled in-between the less- and more-desirable alternatives, reflecting, perhaps, how performance assessment is a sensitive issue for the industry, though there were a good number of delegates hopeful of moving towards the more-desirable future state. Delegates also expected polarisation, with exemplars and laggards, and expected risk-adjusted returns to stubbornly remain the prime focus of measurement. Culture and forward-thinking investment teams will be the catalyst to move past this, with teams, backed by robust metrics on what non-financial good looks like, leading governing boards to be comfortable with holistic measures.
Data | this provided one of the most optimistic views of the future with members seeming to favour a future state where data is transformed into a decision-useful enabler for the future of ESG. Delegates pointed to recent moves by ISSB as a game-changer and a “historic” opportunity to standardise data. There was also hope around the potential role of AI and data-generative modelling to enable the industry to “do it ourselves” and not rely on tech services providers to create ESG data assessments (though there could be issues of costs and the potential for getting the ‘wrong’ data due to cost constraints). There were also some concerns over the role of data in potentially skewing the true ESG investing picture, with some fears over any attempts to “adjust portfolios to make them look as though they have the new alpha”. There also appeared to be general consensus that it was up to the industry to make the ISSB ESG data and disclosure regime work and how moving to a 3-D investment mindset that redefines what good looks like can help to meet these longer, wider-purpose aims.
Stewardship | was expected to be more on the desired future state, though views were still relatively conservative-to-neutral on the outlook for this pillar. To influence stewardship towards a meaningful, desirable, and successful future, institutions will need to embrace systems thinking and assign a renewed system-level focus to a stronger stewardship model, as opposed to simply ad hoc stewardship practices with a minor focus on systems change. Delegates pointed to there being more pressure around “what are you doing about stewardship in my portfolio?” and “better company-level engagement,” but there was still not enough of a challenge to portfolio managers. There were also concerns about weaker stewardship and scenarios where organisations may seek to “excuse performance” using notions of stewardship. To overcome these issues, it was argued that stewardship needs to be wholly recontextualised as a collective rather than a singular issue.
Politicisation | both working group members and event delegates were more skewed towards the less-desirable future state for politicisation, expecting mounting political pressure, causing the industry to operate under the political radar, and to narrow its attention on sustainability factors. This recognises how ESG investing is becoming a “political battleground” and that “we are political players not just amoral return maximisers”, despite the discomfort over this and the power of politicisation to diminish the opportunity set.
Regional models | this generated more negative future expectations, namely regional priorities and regulatory non-uniformity impeding further and faster progress. The considerable divergence across jurisdictions can make global net zero challenging, though more holistic and long-term approaches could address some of the issues. Uncoordinated regional activities were likely to continue, even in the face of moves to more harmonised, global ESG/sustainability frameworks such as those under ISSB, as territories pursue their own political agendas. It was felt the global investment industry has a role in ensuring the solutions it develops are as consistent as they can be, with smarter and more careful philosophy statements that can respond to a fast-moving and sometimes fractured regulatory landscape.
Net zero investing | this garnered a neutral response. Instead of passively reacting to the pace of transition, the industry could make net zero the very core of its processes and behaviours. But much of that possibility is hindered by the overwhelming complexity of the challenge, with the risk of falling behind the expected and required transition. The shift to net zero investing may take 20 years.
Rightsizing and the future of ESG
Bringing this all together, the future success of ESG will be defined by matching ESG aspirations with reality and commitment, that is, by rightsizing. This approach is about not reaching too far and compromising legitimacy and, conversely, it’s not about, “underdoing it” and foregoing the opportunities at stake.
The ESG rightsizing process for a coherent and compelling future concerns developing mind-, skill- and opportunity sets.
In a world where we now have key performance indicators linking executive remuneration to ESG credentials, and pressure on corporates to up the ante on sustainability, it is necessary to find practical actions to be ready for the future of ESG. This will be about fully evidencing the way ESG can add value systematically.
There’s a wider need for purpose and vision to be clear and aligned with strategy. Vision informs strategy, strategy grounds vision in reality.
Rightsizing is also about understanding the role an organisation can play in contributing to society’s toughest challenges, while not trying to be the solution on its own. The industry will need collaboration to overcome the myriad of challenges ahead, as well as a collective high conviction about sustainability. But, as many delegates pointed out, while the future of ESG may be ambiguous and polarising it is simultaneously necessary and unstoppable.
[1] General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and Climate-related Disclosures (IFRS S2)
Read the second 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 rightsizing and horizon-scanning projects, get in touch.