Between Two Rear Ends of a Horse
That’s the title I choose for this report from the Apr. 23 CSR Investing Summit: Measuring Responsible Leadership in New York City.
Topline: CSR Investing offers opportunities for long-term, sustainable value creation. But we won’t find them unless we stop siloing ESG factors mainly in terms of risks and negative screens and start applying ESG factors as value drivers. This holds true not in spite of, but because of, our increasingly unstable and unpredictable world.
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The past was about how ESG helped companies demonstrate their virtue by aligning a company’s actions with its values. The future of Responsible Investing builds on this by also creating value. That’s how Stephen Davis, Associate Director and Senior Fellow – Harvard Law School Programs on Corporate Governance and Institutional Investors, framed the CSR Investing landscape with the first presentation of the day.
Today, we’re somewhere in the middle, according to Davis. We’re searching for the tools, technologies and culture changes that will allow institutional investors to calculate the full impact of extra-financial—but highly material—ESG factors into their portfolio decisions. He cited three converging trends that are transforming the Capital Markets:
- A growing awareness of potential risks and impacts from extra-financial material factors, such as environmental disasters and social issues.
- A surge in measurement and reporting frameworks to help corporations and shareholders measure risks and how to better manage them, such as GRI, SASB, IIRC and S-Networks.
- And thirdly, the rise in what Davis called “shareholder ownership with authority.” Institutional Investors are using the first two trends to take a far more assertive role in how companies are run.
Davis then contrasted these trends with a description of how today’s legacy culture and obsolete infrastructure are unprepared and unsuited to manage these new financial market realities. His analysis is that the Capital Markets are currently stuck between the status quo of “we’ve always done it this way” and the changes bearing down on them.
Thus putting us for the moment, he said metaphorically, “between the two rear ends of a horse.”
He went on to explain that this expression springs from the curious fact that the United State standard railroad gauge is precisely 4 feet, 8.5 inches. A historical review of how we build roads, so the story goes, leads all the way back to the original specification for an Imperial Roman war chariot. So in essence, our railroads are designed to accommodate the back ends of two war horses rather than the key performance needs of a modern transportation system.
While this story paints a vivid picture of how the status quo suffocates innovation, and it pains me to disagree with Professor Davis, the conclusion—modern rail gauge follows Roman road construction—is false. While U.S. rail gauge is exactly 4 feet, 8.5 inches, a strangely precise number, this is a case of convergent evolution rather than direct descent. (The full debunking can be found in this delightfully named 2001 U.S. Department of Defense journal article: “Roman Chariot, Railroad Tracks, MilSpecs and Urban Legends.”)
Said another way, the problem is that we’re hamstringing our future performance by replaying the moves that got us past results. Business-as-usual will not suffice for coming systematic disruptions in how Capital Markets work and the increasingly climatically unstable world in which they seek to operate, according to Davis. We need better ways of looking forward.
Davis’ recommendations for where Responsible Investing needs to head include a vastly better educated and engaged citizen investor community, broad access to transparent ESG reporting tools, and political will.
Much of the rest of the day built on this foundation, with discussions of Board and Director fiduciary duty and performance, calculating ESG valuation, acknowledging supply chain risks and impacts that happen “outside the factory walls,” and integrating ESG factors into the investment process.
I’d like to direct readers to some of the reports and research mentioned during the day:
- Apr. 23 CSR Investing Summit Presentations
- Tomorrow’s Company Report on incentivizing Capital Markets
- Finding the Value in ESG Performance, Dinah Koehler’s research for Deloitte
- Unilever’s Sustainable Living Plan and its global challenges, including that consumers’ use of Unilever products represents 68 percent of the company’s carbon footprint
- IBM’s Corporate Citizen Corps initiative for leadership development, market expansion and citizenship
- Widespread SEC Disclosure Noncompliance Triggered by Material ESG Issues as presented by Global ESG Regulatory Academy
With the exception of Koehler’s presentation, the day’s presentations were mostly silent on the explicit risks of climate change disruptions as outlined by the World Bank’s Nov. 2012 report “Turn Down the Heat.” I was encouraged to hear about admirable progress being made by committed professionals to change hugely complex, interconnected financial systems for the better. And yet, I came away with a feeling of creeping around the edges.
I support a bolder stance by sustainable business and finance leaders to go beyond relative improvement goals based on past performance, to science-based absolute goals based on planetary limits.
So this is the challenge facing the Responsible Investing community: to champion the technology and business changes that allow ESG factors to carry their full weight in investment considerations. And then to make business and investment decisions that accurately reflect the risks and realistically embrace the opportunities that lie ahead.
I’m hopeful for a time when we will no longer need to identify externalities, and measure them, because we will have successfully learned how to responsibly claim them as a natural part of successful, sustainable business.
When this happens, we’ll no longer be behind the horses. We’ll be out in front.