Capitalism needs to be more purposeful

Monday 10 September 2018

Paul Smith, CFA - President and CEO, CFA Institute

Our industry’s effectiveness is best judged relative to its ability to produce sustainable societal wealth and well-being, which are measured directly by financial success. We have a key role in providing investors with foundational and continuous education on ESG and sustainability, says CFA Institute’s President and CEO Paul Smith.

Experts agree that the term “sustainability” has no single definition, nor is there only one way of addressing sustainability in investing. At its heart are the relevance and importance of environmental, social, and governance (ESG) practices, which vary between companies, industries and countries. It’s a bit of a maze, because these entities are literally and figuratively all over the map, making comparison of company practices problematic.

Yet consensus is emerging in many countries that it is asset managers’ fiduciary duty to incorporate ESG factors into their financial analysis, especially when material to a company’s long-term prospects. These factors are relevant for a broad array of investors, including those who pursue dedicated “responsible investment” strategies and particularly for investors who hold global, cross-sector portfolios (universal owners), because positive and negative externalities can arise.

Examples of ESG issues include:
● Environmental — pollution, biodiversity, climate change, water scarcity, and energy efficiency
● Social — employee retention, data protection and privacy, labour standards, diversity, and equal opportunity
● Governance — bribery and corruption prevention measures, whistleblower schemes, executive remuneration, lobbying, competent and independent boards, separation of chairman and CEO, and effective internal controls.

So where do the problems lie, and how can we address them? First, ours is a complex and heterogeneous industry, which makes it challenging to craft solutions that meet every market player’s needs. Companies are subject to a plethora of both short and long-term risks, including those arising from ESG factors. It is essential that investors grasp how effectively corporations are managing these risks and ensuring organisational sustainability. For this reason, transparency and effective disclosure are critical and something for which we all must advocate.

Policymakers need to facilitate greater investor engagement on reporting improvements, specifically coordination and consolidation of reporting initiatives that enable better investor engagement and improved communication of ESG factors. Our Standards and Advocacy teams advocates for adoption of the integrated reporting approach, an umbrella framework encompassing both financial and non-financial information. This approach is currently voluntary and applicable for companies globally, allowing for experimentation with reporting, application of feedback, and distillation of the information most useful for investors. It acts as a vehicle for understanding applicable ESG performance factors that can provide insight into strategy, business models, and value creation over time.

At some point, we will need to shift from voluntary to mandatory reporting frameworks to ensure comparable and informative reporting across a wide universe of companies. Michael Bloomberg is frequently quoted as saying in the Financial Stability Board Task Force recommendations on climate change disclosures (available at that “Increasing transparency makes markets more efficient and economies more stable and resilient.”

Second, as our Future State of the Investment Profession study confirms, capitalism needs to become more purposeful. Though only 11% of investment leaders surveyed currently see the investment industry’s effect on society as very positive, 51% think it could be very positive in the future, contingent on stronger principles. An industry that is truly professional is trusted and value-focused and has a “clean licence to operate”; in the end, both the industry and society ultimately flourish. This is where our community of investment professionals can become more influential, by adding focus to longer- term value creation and sustainability.

When we surveyed investment leaders about the most important skills for future investment leaders, the most cited attribute was the ability to articulate a compelling vision for the institution. Participants reported, however, that this skill is also one of the hardest to find. Leaders say that training particularly needs to focus on developing an ethical and professional orientation. Diversity in its many forms also warrants increasing leadership attention, yet the investment industry is just now starting to see the value of this important factor for improving investor outcomes.

Third, the investment industry lacks institutional commitment to long-horizon investing. Humans are innately weak at doing anything for the long term, and this behaviour is not easy to change, especially when money is involved. We need to see stronger institutional commitment to long-horizon investing in governance, including processes, structures, and contracting. We also need to see changes in firm culture and, most of all, trust in the implementation of long-horizon investing. Effective long-term relationships are based on trust and are about so much more than the numbers.

How can the investment industry promote sustainability? Responsible investment begins by first developing beliefs and governance that are agreed upon at the board and leadership levels. Other mandates will be ineffective until such agreement is in place. I believe that many of our members are well positioned to influence this critical step at the top. The mission
of CFA Institute states that we lead the investment profession “for the ultimate benefit of society,” and I believe this aim equates to investing sustainably. Our industry’s effectiveness is best judged relative to its ability to produce sustainable societal wealth and well-being, which are measured directly by financial success. We have a key role in providing investors with foundational and continuous education on ESG and sustainability, and we fulfil it by including ESG education in the CFA Program curriculum.

Our emphasis on ethics arguably includes considering the effects of investing on both society and the environment. Our member societies have also expressed interest in sustainability. For example, CFA Society United Kingdom is currently involved in a government-sponsored taskforce, chaired by past CFA Institute Board of Governors member Elizabeth Corley, FSIP, that is advising the UK government on how to make social impact investments accessible to a broader range of investors.

A lot is at stake. Literally hundreds of billions of dollars of investor wealth would result from building a stronger, trust-driven, sustainable institutional investment system. We can all play a role in supporting greater investor engagement with companies on sustainability strategies. We can model what it looks like to be responsible investors. As His Royal Highness the Prince of Wales says, “It is not necessarily a choice between making money on the one hand and ‘doing the right thing’ on the other. On the contrary, once it is recognised that ‘business as usual’ is unsustainable, it follows naturally that those organisations which start to develop resilient business models will be the ones that succeed.”

Don’t miss our next webinar: Green bond pricing in the primary markets