Introduction
To support investors in extending or adapting existing policies, programs or practices to the system-level, TIIP developed seven hypothetical scenarios. These scenarios illustrate the nature of these transitions through such things as the re-thinking of purpose, the expansion of their risk management techniques, and the use of tools designed explicitly for system-level influence.
To illustrate these transitions, we chose three different systemic challenges:
- Climate change
- Income inequality
- Availability of sustainability data
Each scenario focuses on an investor from a different silo of the investment world:
- Pensions
- Diversified financials
- Foundations
- Family offices
- Insurance
- Private equity
Each scenario describes the investor and their current status relative to conventional or sustainable investment; the catalytic moment that prompts a decision to change; the challenges in moving forward specific to their institution; their preparation for overcoming those obstacles; the actions they take to do so; and long-term management considerations necessary once that transition to system-level investment has been made.
The purpose of these scenarios is to illustrate seven of the fundamental types of transitions that will arise no matter the type of system challenge or investor. The scenarios assume investors starting from an initial minimal commitment to ESG integration and then portray obstacles that typically stand in the way of a transition to integration of an explicitly systemic approach and steps typically useful in that transition. They are stories about turning points in the journey to fulfilling the full promise of investment: to benefit society as well as the individual. Our hope is that these scenarios help investors today as they address the twists and turns on the road to realizing that potential.
How a Diversified Financial Services Firm Transitions to the System-level
Case Overview: Diversified Financial Services Firm Integrates Systemic Risk Across Asset Classes
A large diversified financial services firm develops consistent principles for integration of systemic risk management into all asset classes and related investment activities.
Key Takeaways
- DEF, a large diversified financial services firm, realized the high market demand for climate-related products. They determined they needed to expand their product offerings.
- Their lending division was the first to develop new offerings, expanding climaterisk assessment due diligence to all loans and initiated new product lines.
- With this expanded offering, the firm began to struggle with tradeoffs—should they refuse entirely to lend to high-risk climate-related businesses or real estate ventures, turning down otherwise potentially profitable lines?
- The central questions facing the organization became: Should all their investment products divest entirely from high climate-risk industries such as coal, oil, natural gas, refining, and oil-field services? Or only the most exposed?
- DEF decided to adopt a company-wide position on climate change, a stance with political implications it previously had been reluctant to take.
- With this position, they would forego lending to and investments in companies substantially exposed to coal and only underwrite those green bonds that had met official Green Bond certification standards.
- DEF’s leadership decided that this more comprehensive solution was appropriate given the potential impact of climate change on the economy in coming decades. DEF division heads created innovative tactics in field building to position DEF as a thought leader, and its asset management group developed investment initiatives and enhancements to distinguish its product offerings.
Case Detail
The large diversified financial services firm DEF has a brokerage and asset management division with $500 billion in assets, commercial and retail lending operations, and an investment banking division that underwrites public equity and bond offerings.
In recent years DEF instructed its internal managers to integrate material ESG issues into their
security valuation models, responded to requests from clients to screen their separately managed accounts on specific ESG factors including climate change, underwrote green bond offerings, and provided home mortgage discounts for energy efficient housing.
At last year’s annual strategic management strategy retreat, DEF’s top executives and leaders from the firm’s three main divisions reported that market demand for climate-related products was growing rapidly. The need to expand offerings across the board was clear. How to do so was not.
DEF’s lending division was the first to see a pathway forward: it expanded its climate-risk assessment due diligence to all loans and initiated new product lines. But they asked top management if they should refuse entirely to lend to high-risk climate-related businesses or real estate ventures, turning down otherwise potentially profitable lines. Executives in its asset management and investment banking divisions faced a similar dilemma. Should all their
investment products divest entirely from high climate-risk industries such as coal, oil, natural gas, refining, and oil-field services? Or only the most exposed?
Or should they develop a range of differentiated products to serve diverse client demand? Similarly, for investment banking: should they refuse to underwrite offerings for firms or projects with high climate risks? Should they underwrite any product that claimed to be a “green bond” or only those certified as such?
DEF’s Executive Committee realized that piecemeal decision-making on such questions across divisions would lead to internal policy and public reputational confusion. Following the leadership of its CEO, DEF decided to adopt a company-wide position on climate change, a stance with political implications it previously had been reluctant to take.
Its initial investment and lending positions were limited—it would forego lending to and investments in companies substantially exposed to coal and only underwrite those green bonds that had met official Green Bond certification standards. It would continue to serve investment clients with different specific climate-change policies through products and services customized to their individual criteria. These policies were to be implemented throughout the firm’s product lines in the coming year, with a review and possible expansion three years out.
In the meantime, the Executive Committee also decided to tackle a question not raised by the division heads: should DEF engage in additional activities that implied a more holistic approach? Although it recognized that the easy answer was not to go down that road, DEF’s leadership decided that this more comprehensive solution to the challenge was indeed appropriate given the potential impact of climate change on the economy in coming decades. Consequently, the Executive Committee asked its division heads across the firm to devise innovative tactics in field building to position DEF as a thought leader, and its asset management group to research investment initiatives and enhancements to distinguish its product offerings.
Further Reading
Steve Lydenberg, Robert Dannhauser, and William Burckart, “Graduating from ESG to Systems: Scenarios for Investors,” Money Management Institute and The Investment Integration Project, October 2020.
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