Time for ESG companies to lead on adaptation
THE ADAPTIVE CO: That’s the mission of Adaptation ESG, a novel movement urging portfolio companies to usher in a new era of sustainable finance
You be the judge. Exhibit A: ESG investments, in companies that implement above-average Environmental, Social & Governance standards, have skyrocketed to $35 trillion in assets under management (AUM), with a recent double-digit annual growth that has stunned investors and analysts alike. The S&P 500, by comparison, is at $30 trillion. The global AUM total amounts to $90 trillion.
After 20 years rising, ESG has joined the major leagues, drawing thousands of companies around the world and yielding returns that outperform non-ESG funds, even in the current crisis and consistently since 2000.
Exhibit B: TCFD, the Task Force on Climate-related Financial Disclosures, offers these companies a clear path to climate adaptation and also provoked a double-take among analysts when it surpassed 1,000 supporting members earlier this year.
Nearly half are investment firms, and almost the same number are NGOs, regulatory bodies, government agencies and assorted others. So that means only a few dozen are actually companies.
Exhibit C: The long-dreaded rise of climate change to economy-disrupting levels has arrived. The nearly $1 trillion cost in the last four years exceeded all expectations, by a wide margin, and Morgan Stanley estimates that will likely surpass $50 trillion in only the next two decades, a conservative number when you hear what scientists have to say. And speaking of scientists, they are increasingly confirming that COVID-19 is itself a climate event, which would count its vast global economic costs to the tally and bring it home rather shockingly and abruptly.
So yes, you be the judge. But this is not a hard verdict to figure out. Consider that the vast ESG investment pool is where we find the world’s progressive companies, leaders, boards and investors. They have earned their stripes since the segment began in the late 1990s by embracing sustainability and launching innovations, products, operations and programs to reduce their carbon emissions and otherwise do their part to solve climate change. With the far-reaching power and resources in that pool, expectations were high.
But climate change was not solved and will likely surpass the 1.5 degree Celsius threshold later this decade on its way to 5C by century’s end. Other forces proved greater, and now the juncture begs for ESG companies to prepare for whatever climate change throws at them — every company, actually, but ESGs are the bellwether. They’re the leaders in the space, with a newfound role and influence in the investment mainstream. If they adapt, the world will follow. Because it must.
We rarely get to live a moment in history when something is as clearly inevitable as the rush to adaptation is today. The imperative, though, is for that coming scramble to be led, to have a model, a path. That’s what ESG portfolio companies can provide.
Two gaps. Two obstacles.
How? By embracing TCFD as assertively and urgently as possible (yes, that’s the verdict) — by extending their sustainability leadership to adaptation leadership, which is not a great leap. They already have sustainability departments, budgets and initiatives, plus tens of trillions in AUM dollars backing them up, thirsting for companies to reach higher and for more companies in which to invest.
That gives us two monumental future-defining gaps we aim to fill with the launch of a novel global movement later this year:
1. There are thousands of companies in ESG portfolios, but only a few dozen in TCFD. They should all join. And why not? After all, TCFD makes adaptation easy with a nearly flawless framework to follow, now embraced by the world’s leading standards organizations, most notably PRI (Principles for Responsible Investment).
2. At $35 trillion, the ESG universe is large, yes, but the total investment universe, again, is $90 trillion. There will always be segments that don’t want to go ESG or won’t qualify. But surely the world can do better than 39%. Given the pace and risks of climate change, the pace and scale of ESG must accelerate.
The first gap is easily the most challenging. What’s holding them back? I led a collaborative effort in late 2018 and early-to-mid 2019 that answered that question, joined by an exceptional group of colleagues from the COMMON global social-enterprise network and the American Society of Adaptation Professionals. We discovered two obstacles in the way:
- Reputation risk, or the fear or unwillingness to be a first mover in launching an adaptation initiative.
- Uncertainty about future climate scenarios (what exactly to adapt against).
We then dug further, mainly into the behavior science behind these impediments, and came away with a pathway any company can adopt to overcome both.
The first-mover advantage
Reputation risk, for starters, must be reframed. The fear of being a first mover, or the risk of disclosing your serious climate risks and losing ground to competitors who don’t announce theirs, depends entirely on how you disclose. Frame it, instead, as taking aggressive action to protect your stakeholders: employees, customers, suppliers, the communities and cities where you do business, and of course, your ESG investors. And shame on any competitor or company not doing the same!
Adaptation allows you to align the most robust, best-practice protection of your operation with that of society, similarly to how you have always aligned your sustainability initiatives — saving the planet for everyone— but better.
Because this time it’s not a future promise. The imperative is here. Climate change is now. Witness COVID-19 and trillions of dollars worth of natural disasters.
Yes, it will be worse in the future, but “let’s adapt today to be ready for whatever comes. And here’s all we’re doing. Let’s do it together.” It is a narrative pivot that turns first-mover into a competitive advantage. But the window is open now. As this movement unfurls and every ESG company gets in, it’ll close. Hopefully soon. Great “problem” to have, naturally, but you want to lead, not follow.
A new future picture
As to the paralyzing uncertainty about precisely what the future holds, this is a classic human bias that comes with three names: Ambiguity Effect, Neglect of Probability, and Optimism Bias. When facing a scenario with uncertain information and data, the perception of risk is heightened. Fear takes over, and the decision defaults to a more optimistic status quo or comfort zone. We see that playing out in risk-management and C-level teams everywhere, including most ESG companies.
Even the few that have adopted TCFD are not weighing their risks against the more daunting scenarios anticipated by the latest climate science, a tendency TCFD is countering with scenario coaching. McKinsey couldn’t emphasize the point enough in this groundbreaking January 2020 Climate Risk Report, where the firm urged companies and investment firms alike to make sure their scenario modeling and probability analyses contemplate worst-case outcomes revealed by the latest climate science.
To be sure, management teams need measurable, projectable financial data, and they already have their hands full trying to make sense of the maze of ESG data in the market. Understating the science, though, renders the whole effort moot when climate events catch companies unprepared. To that end, adaptation adds two layers of data to the equation.
First, climate data, including some not usually calculated by climate models: tipping points, feedback loops, biodiversity effects (like COVID-19) and socioeconomic cascades (like today’s lockdowns and the migrations stemming from fires, storms and sea-level rise). Second, data on everything a company must protect, relinquish, reinvent and otherwise adapt: facilities, suppliers, staff, brands, upstream distribution networks, cash and capital, investment portfolios, all kinds of corporate and customer information, and more.
But here, as the saying goes, perfect must not become the enemy of great, for the good news is that the basic climate scenarios we face are not uncertain at all. Quite the contrary. The science behind these scenarios is blessedly clear. Run all that corporate data. But don’t fall into what behavior scientists call the Information Deficit, where you acquire data but hold it to such a high certainty bar that you still fall short of the change needed — in this case, behavior change toward deeper, more effective, beyond-typical adaptation.
To help break the clash between ambiguity and action, something else is needed, in addition to hard data. Something that works at the level of what is knowable, already predictable, clearly discernible, at the very least interpretable. And that is art and content, film and virtual reality, narratives and storytelling.
As financiers and risk managers hone in on the numbers, writers and designers must convert those numbers and the climate science widely known and reported in papers and studies, and produce dramatic pieces that paint a new picture of the future in ways that are easy to understand and that clear the clouds, ease the uncertainties and clarify the probabilities.
After all, this is in the end a probability analysis. What are the likely scenarios? And those can be painted on spreadsheets as on canvases, by analysts as by artists. Both are desperately needed. Because both inform, but only one inspires. The combination is what shuts the Information Deficit, counters those human biases, and wins the game.
Adaptation ESG: the sustainability movement for our times
So, how do we get more ESG companies to join TCFD and adopt the most robust, best-practice adaptation possible? It will take a smart, sustained movement to reframe the first-mover advantage and break through the cloud of uncertainty and data overload keeping companies at bay.
That, in essence, is a communications calling of the highest order. In the coming weeks, we will be approaching media and comm companies to develop and launch Adaptation ESG with art, content and events designed to shatter the biases and usher in a surge of TCFD implementation and best-in-class adaptation.
Within the ESG space, investment firms, especially those already members of TCFD, are particularly invited to join, given their clear interest in having portfolio companies adapt at the cutting edge, leaving not a thing to chance.
There is one human bias we do aim, not to counter, but to trigger and capitalize on. It is the Bandwagon Effect, where people and organizations wait and wait until enough folks are on board before jumping, as it were, on the bandwagon. And then the behavior change becomes a new normal. Few such changes are more future-critical at this defining moment than having every company in the world adapt to climate change at this level.
If there is one overarching, overwhelming new reality we must live by, it is that society cannot adapt unless companies adapt. In our urbanized world, people and cities are too dependent on food, water, infrastructure and essential services provided by companies, in partnership with governments.
Lots of governments are acting to adapt. By proportion, precious few companies are matching the effort. Among companies, the $35 trillion ESG marketplace is the natural, logical place to go for candidates ready, right now, to lead the way. But they must be prompted. Left to today’s pace, the shift will likely take far longer than we have.
COVID-19 shows us what sudden, abrupt climate events can do. We have to move fast before the next one, or before a string of devastating, compounding events produce an even worse, longer collapse of our systems, lives and businesses.
The ESG space began with one great hope in the late 1990s, then called Socially Responsible Investment (SRI, today a segment of ESG focused on ethical choices) — that companies would lead a sustainable transformation of capitalism and the economy.
I was a journalist at the time, reporting on the rapid growth of assets under management to $3 trillion in 2000. I presented, and my boss embraced, a new unit to publish CSR reports to help clients share their new sustainability stories with the world. I recall the promise like it was yesterday.
But so yesterday that surely was. And so different is today. Sustainability is now expanded, redefined, to mean not just sustainable, regenerative, restorative development, but adapted development, adapted to climate conditions we can no longer escape. They’re upon us. Here. With worse to come.
And so the time has come for ESG leaders to lead again, as they once did and have since been doing on mitigation and restoration. This time, it’s adaptation’s turn.
Alex Díaz, a leading thinker and analyst in the fast-emerging field of corporate climate adaptation, has a long career spanning business journalism, strategic communications, sustainability management, and stakeholder initiatives. He lives in Puerto Rico, at the entrance of the Caribbean hurricane alley, and runs adaptation studio COMMON Future, an affiliate of global social-enterprise collaborative COMMON and the firm leading Adaptation ESG.