#16: Recap: 21st Century Risk Management for Investors: System Change Investing Explained
Last week, in our first of two recaps, we discussed how current responsible investing does not come close to resolving major environmental and social challenges. How this puts businesses, investors and society at growing risk.
In this second part, we summarize what SCI is, how it’s implemented, and the many benefits it provides to investors, businesses and society.
Before We Dive In ...
... let's recap why the evolution of current responsible investment approaches is critical and urgent:
Take Pension funds and other longer-term investors as an example. They are increasingly using science-based scenario analysis to assess climate change and other environmental and social portfolio risks. This is a good first step, but will it save them from mispriced portfolios and long-tail risk? No, it won't! Why? Because the focus is still on symptoms, i.e. climate change and other environmental challenges are symptomatic risks. True risk management can only be achieved by addressing root causes.
Root causes? Where to find them? In our economic and political systems that largely continue to favor and reward degenerative / extractive business practices over sustainable ones. As a result, in competitive markets, it is virtually impossible for companies to transition to truly sustainable business models. Even the most well-intentioned companies mitigate their impacts only up to the point where it remains profitable. If they continue beyond this point while their peers don't, costs usually rise and they risk going out of business.
So, yes, it is the system configuration that keeps companies locked into business models that emit greenhouse gases and cause climate change. This in turn jeopardizes investment portfolios just as much as business and society as a whole.
We hopefully all agree, it's high time to do something about it! Addressing these structural systemic risks is essential for full risk mitigation. Switching portfolios from “brown” to “green” does not address structural risk, and therefore is not a full risk mitigation strategy.
This is where SCI comes in!
SCI uses investing to address structural systemic risks, mitigate them and thus pave the way for a prosperous future for investors, business and society. It helps to nudge companies into creating conditions conducive to life, i.e. to reform systems in such a way that truly sustainable business models are no longer a utopian fairy tale, but actually become possible.
How SCI Works
Enhanced Assessments: In addition to assessing traditional sustainability metrics, companies are also rated on system change performance. As investors shift their focus to these new, more ambitious, sustainability leaders, companies are strongly incentivized to implement system change strategies.
Ease of Implementation: SCI is designed for easy implementation. Investors use enhanced ESG ratings (i.e. sustainability plus system change) in the same ways as current ratings to develop the same types of funds. The SCI team provides all the support needed to integrate system change into existing funds and launch SCI funds. Services include modeling, data acquisition, research, fund development and marketing.
Comprehensive Models: SCI offers several models, ranging from introductory to full whole system approaches. To illustrate, the whole system SCI model is segmented into three metric categories:
traditional to advanced ESG / biodiversity metrics,
mid-level system change (sector, stakeholder, environmental/social issue-level), and
high-level system change (economic, political, social system-level).
Sample metric categories include system change goals and strategies, whole system thinking, public awareness and media campaigns, government influence activities, system change collaboration, addressing specific system flaws, and supporting system change organizations and efforts.
And SCI comes with the first-of-its-kind Global System Change, nature based framework! Here is why this is important:
Accurately rating companies on system change performance requires a frame of reference. The most advanced and accurate system change ratings apply a whole system framework. GSC provides it. The framework uses the laws of nature to define sustainable society and identifies the systemic changes and actions needed to achieve it. Clarifying system change overall enables the optimal corporate role in system change to be defined. Aspects of this become metrics in SCI models.
The laws of nature provide an objective reality framework that helps to move beyond the philosophical debates and differing opinions and biases that often inhibit system change efforts.
Investor & Societal benefits
By addressing systemic change and root causes, SCI enables investors to truly mitigate portfolio risks that are currently largely overlooked, laying the foundation for sustainable future success. Beyond risk, SCI delivers attractive returns by providing strong indicators of management quality and stock market potential. The approach also provides the highest possible sustainability benefits. This enables asset owners and financial firms to attract new investment and position themselves as global responsible investing and risk management leaders.
For society as a whole, systemic change is the single most important action required to achieve the SDGs and ensure long-term human flourishing and prosperity. In the current environment, only the financial and corporate sectors have the power and resources required to drive systemic change in the short timeframe we almost certainly have to avoid system breakdowns.
Stay tuned! Next week we will share our take on the TNFD framework. What’s the link to SCI? Well, you will find out!