Treating your ESG and risk management functions as different entities can lead to organizational dysfunction, double penalties and declining portfolio resilience. Stanford University recommends a better path forward.
Why should investment organizations care: Recent shocks such as the COVID pandemic, natural disasters and socio-political turbulence proved that ESG factors have a substantial impact on your asset values, and present both risk and opportunities.
Consider these polar opposite numbers:
- Risk – $825.4 billion is the cost of weather and climate disasters in the U.S. that resulted in damage of at least $1 billion each over the decade that ended in 2020.
- Opportunity – $1.5 trillion is the value of new revenue opportunities from low-carbon goods and services, according to European companies in their 2019 disclosures to CDP.
Here’s the catch: As wealth management and private equity organizations grapple with ESG risks and opportunities, they are forced to make short-term, almost knee-jerk decisions in siloed environments rather than adopt a cohesive ESG and risk management strategy.
“It is almost as if investment leaders are stuck between a rock and a hard place: they need to consider ESG factors in the near term, while simultaneously dealing with the pressure to avoid excessive short-termism in managing risk in their investment process,” says Ashby Monk, Executive Director, Global Projects Center, Stanford University
Mind the gap: “Chief investment officers and asset managers need to move past looking at risk from only a loss or volatility perspective as it promotes short-termism, suppresses innovation, and most importantly, deprioritizes the role of ESG on asset value,” adds Monk. This lack of integration between ESG and risk management imposes a double penalty by making general risk management too insensitive to ESG risks and making ESG concerns disconnected from overarching, day-to-day risk management.
Despite the downsides of a siloed approach, ESG analysis and risk management are still treated as separate functions by most investment organizations (especially institutional investment organizations, such as public pension funds, endowments, and sovereign wealth funds). Hence, it’s critical for wealth and asset management leaders to think in terms of resilience and not just risk.
Rethink resilience: Most rudimentary definitions of resilience center around the capacity to adjust to change while maintaining core capabilities, however, Stanford University’s new framework urges wealth managers and investors to rethink resilience in terms of a perpetual and constructive response to both “change signals” and the actual change.
This results in a proactive stance in the face of volatility. Organizations and portfolios are enabled to become more flexible and innovative. As an asset management leader, you would need to focus on continuous detection, smart absorption, efficient recovery and systematic optimization through learning that can help your organization stay nimble and resilient. Easier said than done! This is exactly where technology and data come into play.
Factor in technology and data: “Having high-quality, well-aligned ESG data can significantly help in integrating ESG and risk management,” says Frank Meehan, CEO of Equilibrium, Part of FiscalNote. In essence, your systems and data need to be resilient, too. At the very least your sustainability and carbon footprint management system needs to tick three boxes:
- Comprehensive
Meehan recommends investigating if the platform can cover the current landscape of the “E”, the “S” and the “G” portfolio metrics. Oftentimes, investment leaders only are able to monitor and audit the carbon footprint side of things when the regulatory environment and stakeholders are also interested in a more holistic picture. - Scalable
“Future-proof your technology investment by understanding how quickly your data management platform can adapt to the everchanging regulatory environment, your growing supply chain and vendor ecosystem, and geographic aspects of your portfolio,” adds Meehan - Actionable
Question if the data dashboards help cut through the very noisy ESG landscape? Are the reports shareable across multiple teams and stakeholders and most of all, are you investing in just a platform or a true solution with ESG experts to also guide you?
