How Can Investors Help Create System Value?

By Bill Baue & Ralph Thurm

“To prosper over time, every company must not only deliver financial performance but also show how it makes a positive contribution to society,” stated BlackRock CEO Larry Fink in his annual letter to CEOs in January 2018, which was described by Forbes as “electrifying.” The world’s largest asset manager subsequently issued commentaries on how it engages with portfolio companies around five key societal issues: climate risk; diversity; executive compensation; human capital; and purpose & culture. Such leadership heralds a sea change for the positive role of investors in promoting priorities aligned with necessary transformative change.

What’s the issue?

Before endorsing this proclamation, it’s necessary to assess the walk / talk ratio to discern the alignment between aspiration and action. The month before, Preventable Surprises had issued its Missing 55% report examining how the ten largest investors voted on 2017 shareholder resolutions asking nine utility companies to issue climate risk reports on their exposure to the forces driving a 2°C transition. BlackRock voted against all nine resolutions. And when factoring in the size of its holdings BlackRock scored second-worst. In other words, BlackRock used the booming volume of its voice to deliver a message rubber stamping the entrenchment of climate risk instead of transforming it.

Figure 1: 10 Largest Investors Weighted Voting Record on Climate Risk Resolutions at US Utilities, 2017 (Source: Casey Aspin, The Missing 55%: Voting records for the 10 largest utility investors show divergence on climate risk, Preventable Surprises, December 2017)

Invited to rationalize the seeming disconnect between BlackRock’s public support for climate action, and its actual voting record on climate resolutions, Michelle Edkins of BlackRock skirted the core issues:

“BlackRock believes that engagement is the best way to drive change on important environmental, social and governance issues because we are often engaging with companies on these issues in the absence of shareholder proposals. As a long-term investor, we are willing to be patient with companies when our engagement affirms they are working to address our concerns. However, our patience is not infinite — when we do not see progress despite ongoing engagement, or companies are insufficiently responsive, we will vote against management. We view a vote against management as a sign of a failed engagement not as the start of the process.”

Reasonable people would view a vote against management on a proposal meriting support — such as common sense transparency on an issue as core to utilities’ operating environment as the emerging climate transition — to be the core duty of fiduciaries. The political calculus of engagement does not obviate the duties of care and loyalty. Aspin pointed out in a 2018 blog post that “no public accounting exists” for behind-closed-doors engagement, leaving companies and asset managers unaccountable. Asset owners — and the public at large — have no line of sight to the terms of engagement, but they do see asset managers’ voting records.

Why it’s important?

Stepping back, the BlackRock case is emblematic of emerging expectations that companies — and the investors who finance them — transcend making a positive contribution to society, and extend to eradicating negative impacts on society. Investors — particularly so-called universal owners whose portfolios contain holdings across entire economies — now exert society-shaping force. So, investors can reinforce systemic stasis, or enforce systemic change.

When systems are demonstrably degenerative (as the red in Figure 2 below shows), then such institutional investors can direct capital in ways that reinforce this degeneration, or deploy capital toward regenerative systems. Perhaps more importantly, mega asset owners — and the asset managers who conduct the actual transactions — exert significant leverage on the scale and pace of change — or the relative degree of stasis.

Figure 2: Overshooting Ecological Ceilings and Shortfalling Social Foundations (Source: Kate Raworth, “Meet the doughnut: the new economic model that could help end inequality”, World Economic Forum, 2017)

To state it more clearly: incremental change in the general right direction may still be insufficient to solve the super wicked problems society faces. Alex Steffen labels such insufficiency “predatory delay” — or “the blocking or slowing of needed change, in order to make money off unsustainable, unjust systems in the meantime.”

How can you tackle it?

Addressing super wicked problems such as climate change requires expanding the scope of risk. Investors’ traditional risk assessment focuses on the enterprise level for companies and the portfolio level for baskets of holdings. However, risk now aggregates to the next level of systemic risk (which actually transcends the common definition focused on the financial system to encompass social and ecological systems as well). Indeed, climate scientists have introduced the idea that climate change poses “existential threats to the survival of humanity” that “could include species extinctions and major threats to human water and food supplies in addition to the health risks posed by exposing over 7 billion people worldwide to deadly heat.”

We at Reporting 3.0 also extend the risk continuum in the other direction as well — to the nano level of career risk faced by individuals. We propose that Positive Mavericks must confront career risk (what one of our commentators called the “risk of being ousted, ridiculed, scapegoated, downplayed or eliminated”) in order to advocate for tackling existential risk.

Figure 3: The New Risk Continuum (Reporting 3.0)

Risk at the individual level also now extends to fiduciaries, who are increasingly exposed to vulnerability of legal accountability for failing to fulfill their strategic duty to create “durable, long-term wealth” — and even “societal wealth,” according to Delaware Chief Justice Leo Strine.

What will you have achieved?

This framing aligns with Reporting 3.0’s call for creating system value, embracing the concept proposed by the Future Fit Foundation. We believe that the urgencies of 21st Century mega trends compel 21st Century investors to respond in kind by transcending and including shareholder value and shared value, in order to create value for all systems within which companies and investors operate. As one investor we work with stated, failure to address systems-level imperatives simply creates opportunity costs of delaying this inevitable necessity. We look forward to working with more investors who recognize the need to create system value as the new strategic duty of fiduciaries.

What will we discuss next time?

How can Governments, Multilaterals and Foundations learn from Reporting 3.0’s Work Ecosystem? Please read part 22 here.

[Context of this series: This is part 21 of the Reporting 3.0 series that forms the basis of an Implementation Guide that summarizes the total value of Reporting 3.0 in implementing a future-ready sustainability strategy and disclosure approach, in line with the idea of a Green, Inclusive and Open Economy. By posting these articles here Reporting 3.0 seeks feedback in the writing process of the final document, to be released as Blueprint 5 at the 5th International Reporting 3.0 Conference in Amsterdam, The Netherlands, on June 12/13, hosted by KPMG, see www.2018.reporting.org]