Regulators are increasingly calling on investors to consider systemic issues.
Most recently, the U.S. Securities and Exchange Commission proposed updates to its regulations for advisers of hedge funds and private equity funds, calling on them to assess systemic financial risk in their reporting on the funds. Similarly, the U.K.’s Financial Reporting Council updated its Stewardship Code in 2020 to direct investors to “identify and respond to market-wide and systemic risks to promote a well-functioning financial system.”
These regulatory changes recognize that systemic challenges have profound effects on market returns. Climate change poses an existential threat to the reliable functioning of markets — to say nothing of the other systems we rely on for our health and well-being. Accelerating income inequality is further destabilizing the foundations of our society as the chasm between rich and poor widens, leading to political strife and uncertainty. The social constructs of race and identity, including gender, sexuality, ability and neurodiversity remain key markers for health and economic outcomes. Taken together, these trends point to a potentially bleak future: one of greater market disruption and more instability for asset owners and managers.
Fortunately, a growing number of “system-level” investors are responding to the call for greater management of systemic risk. These investors go beyond traditional environmental, social and governance approaches, managing systemic risk by incorporating aspects of system-level investing. These investors, which include the $476.9 billion California Public Employees’ Retirement System, Sacramento; NZ$60 billion ($41.7 billion) New Zealand Superannuation Fund, Auckland; and The Church Commissioners for England, London, which manages the Church of England’s £9.2 billion ($12.1 billion) endowment, believe a primary responsibility of investors in the 21st century is to ensure that their investments intentionally support the health and resilience of crucial systems, reduce systemic risks and promote opportunities for all.
Integrating systemic risk considerations can also support fiduciary responsibility as it helps investors manage intergenerational risk and return effects that issues like climate change pose to portfolios and that can degrade future returns.
Yet, there is a fundamental concern as this nascent investing movement rises to the challenge to tackle these global issues. We are staring down a potential greenwashing crisis just as system-level investing comes into its own.
At issue: While some investors can say they are doing system-level investing, there is no established methodology to measure and assess their performance.
There are several ESG measurement frameworks, such as the International Finance Corp.’s Impact Principles, the Global Impact Investing Network’s COMPASS methodology for comparing and assessing impact, the World Economic Forum’s metrics for assessing stakeholder capitalism, and the Institutional Limited Partners Association’s ESG Data Convergence Project. These are all critical, valuable contributions to the field and help investors understand the portfolio-level impact of their investments. But, we …….