Foundational research by CFA Institute aims to prompt the best minds in the asset management and asset owner communities to consider how to better consider climate risk. Institute chief executive Marg Franklin says governance, organisational design and systems thinking will be core elements of how the industry evolves its thinking and actions.
Entrenched systems and behaviours in the finance industry are hindering investors’ ability to adequately consider climate risk, says Marg Franklin chief executive of CFA Institute, which has just launched foundational research that examines practical ways for the industry to tackle climate risk.
Net Zero in the Balance: A Guide to Transformative Industry Thinking, a new paper by CFA Institute written by Roger Urwin, is the anchor for a series of research, qualifications and practical tools that the organisation will launch around climate risk.
“We will offer a portfolio that includes education, influence, research, and tools,” Franklin says. “You need qualified competent individuals, research and guidance to shape the thinking and influence the industry.”
The genesis for the paper, which also has contributions from many industry leaders, came from a monthly call between Urwin and Franklin where they discuss how the CFA can help untangle some of the entrenched systems, processes and behaviours that, like a bad relationship, don’t serve investors but are too difficult to see from the inside. The use of backward-looking data for investment analysis, attribution and prediction is one example.
“The industry is increasingly more creative, but it is still backward-looking, especially for valuation, and yet we recognise that net zero needs to be forward-looking,” she says. “We want to examine if some processes are fit for purpose and if not, how do we think about them going forward in the context of a rapidly changing environment.”
The paper stresses the importance of mindset shifts and transformative thinking, highlighting some strategies for success such as balanced scorecards, total portfolio thinking, universal ownership and stewardship.
A focus on systems thinking
It emphasises how investors can improve governance and organisational design including a focus on systems thinking which is not well understood in the industry.
“That gets you your frameworks to allow you to be effective and thoughtful in very complex systems and bring together people with investment and operating models,” Franklin tells Top1000funds.com in an interview.
She encourages fund managers and asset owners to be more creative and bolder in their thinking, including looking at signals from other parts of the finance ecosystem such as insurance.
“Increasingly we are looking at how asset-manager and asset-owner businesses compare to the rest of the financial system,” she says.
“Insurance is the canary in the coal mine, and managers could look at signals from other parts of finance.”
Franklin believes asset managers and owners aren’t as effective in assessing climate risk as players in other parts of the industry because benchmarks and incentives for performance measurement are not suitable.
“That starts to translate into how the system is set up and if it is fit for purpose, and you start to think it isn’t,” she says. “You can’t violate the risk and return equation, that is first. But then how do you incorporate climate into that and the levers that are available to have portfolios climate proofed or climate neutral or both, managing risk and capitalising on opportunities. That gets to portfolio construction, manager evaluation, and whether you have the governance and policies in place to make that happen.”
The data obstacle
Investors frequently cite common obstacles, data being the most obvious. It is well documented that data is often not robust or harmonised when it comes to climate risk analysis, but Franklin believes there’s also a behavioural aspect that is not as well debated.
“Are you big enough to be a leader?” she says. “Do you have a strong enough board to do something different to your peers? Can we explain things in different ways that are more complex than just a comparison to the S&P? Can you think about risk differently?”
The net zero paper is the foundational piece for a body of research work by the CFA including a deep dive into time horizons, incentives, benchmarks and systems thinking.
Franklin says the role of the CFA is to get the conversation with the industry started in a meaningful way that she hopes will be dynamic, and which could include some provocative suggestions on how the industry can change.
“I want people to square off, I want to put the greatest minds on it,” she says. “Hopefully we will be seen as very industry-oriented, and an intellectually robust public square or forum for this.”
Like CFA’s volume of work on diversity, equity and inclusion, the research, education and tools on climate risk will invite investors to think about the foundational infrastructure of the industry including questioning how risk is incorporated and managed, and how to structure and communicate with a lay board in a more complex world that keeps the focus on the beneficiary.
“It’s also important to consider right sizing for where you are,” Franklin says.
“And our offering is a variety of research, tools and education to help you think about what to actually do within your own system depending on where you are starting from.”
The next article in this series, with the CFA Institute, is an interview with Roger Urwin, chief author of the report “Net Zero in the Balance”.
