The 2025 proxy season suggests a necessity for a comprehensive overhaul in the realm of sustainable investment.
In the rapidly evolving world of finance, many investors are recognising the importance of addressing systemic risks in their strategies, understanding that the long-term value of their portfolios depends on supporting the systems their investments rely upon. However, conventional Environmental, Social, and Governance (ESG) approaches have been falling short in addressing systemic risks, particularly those related to climate change.
The focus of traditional ESG strategies has been on how sustainability issues might impact a company's financial performance, rather than on how the company affects the broader world. This 'inside-out' perspective limits ESG's ability to challenge harmful business models or incentivize meaningful systemic change. As a result, companies can receive high ESG ratings while still engaging in practices such as pollution, labour exploitation, or lobbying against climate regulations, leading to what is known as greenwashing and misleading investors.
The Volkswagen emissions scandal serves as a stark reminder of this shortcoming. Despite strong prior ESG scores, the company's systemic misconduct went undetected, resulting in massive fines and reputational damage.
Systemic risks like climate change pose threats to the entire economy and financial markets, challenges that cannot be managed adequately through firm-level risk controls alone. Conventional strategies such as ESG integration and divestment do not confront the broader economic damage caused by emissions. Instead, investors need to address the root drivers of climate breakdown to protect long-term value and the health of the overall market.
To better confront these challenges, experts and organisations suggest system-level investing strategies that go beyond risk management and focus on real-world impact. These strategies involve capital allocation, corporate stewardship, policy advocacy, and service-provider accountability.
Capital allocation strategies should focus on primary markets, where companies raise new funds for operations and growth, and restrict financing to polluters without credible transition plans, while scaling investment in climate solutions. Corporate stewardship involves using shareholder voting, engagement, and bondholder influence to hold companies accountable for emissions, capital spending, and lobbying activities.
Policy advocacy is essential, especially as government action lags and corporate influence continues to obstruct progress. Investors have a responsibility to support robust climate mitigation policies, such as emissions limits, clean energy incentives, financial regulations, and reforms to lobbying practices, to drive economy-wide decarbonization.
Service-provider accountability ensures that asset managers and advisors integrate systemic climate risk into their mandates to align intermediary actions with long-term fiduciary duties.
This approach emphasises credible impact over symbolic ESG alignment, requiring investors to leverage their full influence to accelerate decarbonization and build a more sustainable economy, rather than merely avoiding risk or divesting from certain companies.
In the current political environment, particularly in the US, the 'anti-ESG' backlash has led to tepid support for climate-related shareholder resolutions during the proxy season. Despite this, addressing systemic risks is part of investors' fiduciary duty, as climate action is central to economic stability and long-term portfolio value.
Investors must start working to mitigate climate change, as protecting the health of the economy from climate breakdown is in most investors' best interest, even when it conflicts with some companies' short-term incentives. Asset owners must hold their service providers to account, updating mandates or reallocating capital if intermediaries aren't taking steps to mitigate systemic risk.
Perpetuating a financial system that defers to corporate self-interest over global prosperity and resilience is no longer tenable. By adopting system-level strategies, investors can help ensure a sustainable and resilient future for all.
- To address the shortcomings of traditional ESG strategies in tackling systemic risks, particularly climate change, investors are encouraged to shift from a 'inside-out' perspective to system-level investing strategies that focus on real-world impact.
- In addition to capital allocation strategies that restrict financing to polluters without credible transition plans, investors should also engage in corporate stewardship to hold companies accountable for their emissions, capital spending, and lobbying activities.
- beyond risk management, system-level investing strategies also emphasize policy advocacy, where investors have a responsibility to support robust climate mitigation policies to drive economy-wide decarbonization, as addressing systemic risks is part of their fiduciary duty.
