Sustainability Stars: Tracking ESG risk with CalPERS’ Anne Simpson

Why mandatory climate risk reporting, carbon pricing and integration of disclosure with financial statements are vital goals of COP26, and the $480 billion California pension fund.

By Marsha J. Vande Berg

(Marsha J. Vande Berg is CEO of MJVGlobal Insights, serving as an educational resource to corporate and investment executives about sustainability, governance and political economies. As CEO of Pacific Pension and Investment Institute, she worked closely with global pension executives, particularly in the Asia Pacific. A Stanford Distinguished Careers Fellow, she teaches, writes for international publications and is a frequent forum and webinar speaker. Reach her on LinkedIn or Twitter.)

SAN FRANCISCO (Callaway Climate Insights) — The momentum behind sustainability finance in today’s marketplace is due in no small measure to the catalytic role of institutional investors, who early on recognized climate risk as a systemic risk to their long-term investment portfolios — on which millions of future and current retirees depend.

Now doubling down because the available information about climate risk is asymmetric, meaning uneven in its credibility and reliability, investors like Anne Simpson at CalPERS are boldly articulating how climate change also puts at risk our financial system — the very lifeblood of our economy and way of life. 

It’s no small undertaking that occupies the time and energy of Simpson, CalPERS’ veteran expert on corporate governance and who last year was named CalPERS Managing Investment Director of Board Governance and Sustainability. She sits on the all-important investment committee of the $480 billion pension fund. She was the driving force in 2017 when an important CalPERS initiative became Climate Action 100+, an alliance of funds responsible for $55 trillion in assets and whose objective it is to bring the world’s top greenhouse gas emitters to heel.

Simpson was one of the “early responders” at CalPERS calling attention to climate change and other ESG-related risks in the portfolio. She pushed successfully for early integration of ESG risk factors across all asset classes, the 2016 adoption of the fund’s Sustainable Investment Strategic Plan and then its monitoring. Just last June, she briefed the CalPERS Board of Trustees on the Plan’s “mission accomplished.

Last year, Barron’s named Simpson one of the 100 most influential women in finance. In addition to her CalPERS engagement, she serves as a Lecturer in Sustainable Finance and Impact Investment at the University of California Berkeley’s Haas Business School and is a Visiting Fellow at Oxford University. She is a member of the London-headquartered OMFIF advisory board. She is one of three co-authors of The Financial Ecosystem: The Role of Finance in Advancing Sustainability, published by Palgrave MacMillan.

Simpson is one of six children raised by a single mother in the UK. At Oxford University, she read philosophy, politics and economics, and joined CalPERS in 2009. She has a wry sense of humor, is well-spoken and articulate. Her contribution to sustainability finance is and will continue to be commanding.

I interviewed Simpson in mid-August via Zoom after she had returned to her home in the foothills between Sacramento and Tahoe, Calif. It was a rescheduled call because the smoke and debris from the massive wildfires now raging in 13 locations across Northern California was so strong that she had had to leave home temporarily, cancelling appointments. Now back, she readily held forth on a range of issues about sustainability finance, risk and pending policy and regulatory actions. The full interview is available here. We hope you enjoy the interview as much as I appreciated doing it.  

Question: While some describe sustainability finance in terms of impact and doing good, public fiduciaries like CalPERS are in the vanguard of articulating how risky circumstances external to a company’s circumstances, can impact an investment portfolio. How do you explain the investment thesis that characterizes sustainability in terms of risk and opportunity?

Simpson: Risk is essential to managing returns. There are no returns without risk. So it’s very important to remember risk is fundamental to the day job of an investor. Just to put context to this, although CalPERS has a very large asset base — some $480 billion at the moment — we are still only 80-percent funded. The painful work of restoring full funding means that we have to keep an eye on both our risk-adjusted target rate of return… and our current liabilities. We pay out something on the order of $25 billion a year in benefits… Managing risk uncertainty and our ability to generate the cash we need are both fundamental to what we do.  

Question: What is your definition of risk in today’s investment context? Has your thinking about risk evolved?

Simpson: In rethinking how CalPERS was going to both create sustainable long-term value and maintain our ability to generate cash — a very demanding job — we decided to go back to the drawing board and look at what investment means and then what are our investment beliefs. For the first time in CalPERS history, we developed a set of investment beliefs which in turn set the stage for all our work on sustainability.

The first belief rightly says our liabilities drive how we deploy assets; the second, recognizes that as long-term investors we have an advantage — and responsibility to engage policy makers as well as company managers. The third is about our responsibility to be responsive to stakeholders. The fourth — which was really innovative and which has since been copied by others — says the investment process needs to effectively manage three forms of capital — financial — which is the traditional job of an investor, human capital and physical capital or natural assets essential to prosperity and overall investment success.

There are six other beliefs, but the importance of these four and especially the fourth which embraces the three forms of capital has been underscored by concerns and circumstances today — climate change, the COVID pandemic, social dislocation, racial justice and gender equality … So what CalPERS did in 2013 was adopt the concept of these three forms of capital to guide our investment strategy. It meant that we as investors began to think about capital allocation — and stewardship.

(Simpson writes about the three forms of capital in her book, The Financial Ecosystem, co-authored by Satyajit Bose and Guo Dong.)  

It meant we set a fresh, new agenda for investment. For example, it became important to ensure that directors of corporate boards (in companies where CalPERS was invested) as well as our fund managers understood where long-term value comes from. We had to make sure that corporate reporting about these three forms of capital informed our understanding of value creation (on the part of the equities CalPERS owned).

Yet another investment belief says that risk for CalPERS is multifaceted and can’t be fully captured with traditional risk monitoring tools, such as tracking error and volatility. This meant we could single out other issues we saw as systemic risks, such as demographics and natural resource availability, which can be everything from fresh water to rare earths and minerals.

What came next was how to address putting these beliefs into practice. First we commissioned an extensive review of the research. This was our Sustainable Investment Research Initiative (SIRI with a nod to Apple)… We had to be sure that an issue mattered whenever, wherever and however capital was to be allocated. We then did this stock-taking exercise and counted no less than 111 different initiatives that could come under the umbrella of ESG (the environment, social and governance factors).

But the purpose was to get a strategy that integrated our thinking and our investment beliefs, the three forms of capital, multifaceted risk, exercising stewardship and capital allocation — and that would allow us to move forward with reasonable conviction. We then developed a five-year strategic plan on sustainable investment.

We were one of the first, if not the first major asset owner to do this. The plan also identified themes with climate change first but also board diversity and asset class-specific work on transparency and alignment. In private equity, we set a goal to make sure we had better alignment across fee and performance transparency and across all of our asset classes, 100% of our policies and decision-making were informed by our insight on sustainability. Ultimately, this set each of our asset classes on a path to develop sustainable investment practice guidelines (SIPGs) that reflect their particular strategies.

The total fund strategy for sustainable investment also meant that we could identify the channels where we could be effective, starting with engagement. Another track was our ability to advocate with regulators to make sure we can get what we need from data and corporate reporting as well as to address market inefficiencies. The third track was integration — and this was our bold ambition to make sure we integrated (our understanding of sustainability risk and return across the total fund). The fourth track is partnership. Although CalPERS is one of the world’s largest asset owners, anything that we do needs to be in partnership with others.

It’s really been a grand adventure. We’ve done a lot and yet we know that we are really only in the foothills of a very long climb to get this work right.

Question: How do you square concepts like materiality and double materiality with your approach and that of CalPERS to risk and opportunity? What is materiality and double materiality?

Simpson: The question of materiality is beguilingly simple. First, I have to applaud the Sustainability Accounting Standards Board (now Value Reporting Foundation) which is led by former CalPERS executive Janine Guillot. It was SASB that identified materiality as the driver of better data disclosure and corporate reporting.

But that raises the question of whether this definition of materiality can apply globally — in a world where we have two sets of accounting standards, the US GAAP and the IFRS. For US GAAP, administered by FASB which is overseen by the SEC, defining materiality implies looking at what impacts the financials of a company. The focus is at the issuer level.

But there’s another angle, which SASB fully acknowledges, and that is the definition of materiality based on U.S. Supreme Court rulings, namely that materiality is what a reasonable investor would expect when making decisions about investments.

Consider CalPERS with its 100 years of liabilities. We are a universal owner, meaning we own a little piece of everything. For us there’s nowhere to hide. We are just too big. We’re diversified across so many holdings that materiality at the issue level is somewhat mitigated. If we own only 0.3% of a company, it’s very hard to see how materiality at the issuer level will impact us. But if you roll up all the greenhouse gas emissions coming from companies, then CalPERS portfolio may face a systemic risk, namely climate change.

That in a nutshell is how we understand double materiality. There’s materiality at the level of the company which directly affects revenues. And if an investor owns a section of the market, then the investor is exposed to double materiality.

It also goes one step further — materiality that is the result of (negative) externalities, how a company deals with these externalities and how that impacts society. … A recent court ruling in the Netherlands found Royal Dutch Shell (RDS.A) responsible for the impact of hazardous emissions generated by its products and ordered the oil company to reduce Shell Group’s emissions by net 45% in 2030. Companies not taxpayers should pay for the impact on society — and that is the European approach to double materiality.

(Shell now says it will appeal the May landmark court ruling by the Hague District Court.)

CalPERS has spoken out in support of the concept of double materiality because as a universal asset owner we’re exposed at the issuer level when risk is rolled up and that traces to the impact of externalities. It’s because of the longevity of our assets. Having such a long-time horizon means that ultimately we are exposed to risks of impacts on society. 

Question: Soon, the nation-signatories to the 2015 Paris Accords will meet for COP26 in Glasgow. What do you predict will be the outcome(s) of the November meeting of the globally concerned? Do you anticipate the outcomes will make your life at CalPERS easier or more difficult?

Simpson: First we need to remember what COP26 was intended to do. It was to be a check-in after five years on the commitments that the signatories made in 2015 in Paris. Nations made individual commitments to meeting the Paris goal of holding any increase in global warming to well below two degrees Centigrade. We have had progress since then.

Japan came forward with a net zero pledge by 2050. President Biden made the same pledge for the United States. China came forward, too, as did markets like South Korea, the United Kingdom and New Zealand. So the ambition at the national government level has ratcheted up. The question now is what actions will each nation take in support of their commitments? What will be the policies that drive change?

Financial markets are looking for two things that still are missing. One is information. We can’t postpone any longer the call for mandatory climate risk reporting. There are good efforts underway here and there. The IFRS and the SEC now see this as mission critical. So we are expecting that COP 26 will provide a commitment on that.

“Information is the No. 1 issue, and No. 2 is incentives. We know that markets work efficiently when incentives are aligned. Markets need information, and they need for incentives to be aligned.”

We know too that the COP26 team has been working on what’s kind of hilariously called a road map. Maybe they should be working on a pathway for more than electric vehicles — for walking and bicycles or other forms of low carbon transport, for example. Each market needs a pathway to get to the point where they can integrate mandatory reporting requirements. That would be fantastically helpful.

Information is the No. 1 issue, and No. 2 is incentives. We know that markets work efficiently when incentives are aligned. Markets need information, and they need for incentives to be aligned.

We also are hoping for progress on carbon pricing and the removal of subsidies for fossil fuels. These are two immediate measures that have been on our to-do list for regulators and policy makers ever since the Paris meeting in 2015.

We also need to be looking at the incentives that are being set for company executives and for fund managers. The incentives that are put in place internally need to be aligned with external factors. Otherwise we’re not going to get there.

Executive compensation is one of the measures called for by Climate Action 100+, namely that emission reductions at a company be a hurdle in executive compensation plans…And we are getting companies to do just that. One example is BP which now has its top 14,000 executives in a bonus plan that ties rewards to emissions reductions.

So the big agenda is twofold: Getting information to the market and second, ensuring incentives are aligned. Underneath all that is an enormous amount of investment and public policy to make sure the necessary infrastructure is put in place. That includes phasing out coal and providing support for developing countries so they have access to the technology and expertise they need to get things right.

Climate change is a huge challenge. It’s No. 13 on the United Nations list of 17 Sustainable Development Goals (SDGs) which have been agreed everywhere from Russia to Saudi Arabia to China and the United States. Everyone is signing up — but things also have to be done in ways that are equitable and that pay proper attention to the concept of a just transition. That’s an integral part of the Paris agreement.

Question: On or before the November meeting in Glasgow, there is the possibility of at least two, maybe three initiatives establishing operable climate change disclosure requirements and mandatory corporate reporting to regulators. One initiative is well underway in the EU. Another is the current work of the IFRS Foundation, which appears headed toward setting standards and a global Sustainability Standards Board to oversee enforcement. Meanwhile, the SEC in Washington is considering its own disclosure requirements. How sanguine are you about the possibility of an outcome that harmonizes these and any other initiatives that might surface? Is harmonization even the optimal outcome? Would it be better to live with more than one set of disclosure requirements like we now have with the dual accounting standards?

“Ultimately, the great prize will be if we can integrate disclosure with financial statements.”

Simpson: On the IFRS side, there’s going to be an effort to carefully coordinate with and draw on the expertise of various groups — the Sustainability Accounting Standards Board (now the Value Reporting Foundation); GRI (the Global Reporting Initiative); the International Integrated Reporting Council (now merged with SASB under the Value Reporting Foundation), the Carbon Disclosure Project and the Climate Disclosure Standards Board as well as the Financial Stability Board’s Task Force on Climate related Financial Disclosures.

Ultimately, the great prize will be if we can integrate disclosure with financial statements. If we can get all that done, well, then the question becomes do we have two sets of accounting standards. In recent years, we’ve seen not quite convergence but a harmonization – or the dream of a common language being realized between IFRS and GAAP reporting requirements. The SEC, for example, acknowledged that a lot of progress has been made when it dropped the need for separate reconciliations.

(GAAP or Generally Accepted Accounting Principles are set by the Financial Accounting Standards Board (FASB) and followed by U.S. companies primarily. IFRS standards or International Financial Reporting Standards are practiced by companies in much of the rest of the world. Some companies report using both sets of rules.)

That agenda has moved forward very well — and remember the SEC is represented on the monitoring board that oversees IFRS rules — so there is connectivity at the highest level as well as at the departmental level. I’m confident that the dream of a common language will be realized. Why? Because we have global capital markets, and investors don’t want to have to check their passports at a false border called the Atlantic Ocean or the Pacific Ocean or the Canadian Border or the border with Mexico. Right? It’s a global market so we need global standards.

Question: Specifically as to the SEC initiative, CalPERS’ CEO Marci Frost recently filed an impressive response to the regulator’s invitation for public comment on its apparent plan to put in place some form of disclosure requirements.  Undoubtedly the document reflects your considerable contribution. What does an optimal set of disclosure rules set forth by the SEC look like from where you sit?

Simpson: We’ve had several meetings with SEC Chair Gary Gensler and his team. He is dead serious about getting this job done, and not just on climate risk, which, granted, is front of mind for everyone. He also wants to look at the regulatory agenda concerning human capital management reporting. Although it’s been years since CalPERS first began talking about all this, we really are starting to see momentum now among regulators — also by investors who support these ideas.

Sustainability must have an inclusive approach. It has to reflect thinking about the three forms of capital if we are going to do sustainability in a holistic way.

The optimal outcome is that the SEC sets the standards or incorporates the work of a third party, for example, SASB (the Value Reporting Foundation) or TCFD, however it’s most useful to think about this. Groups like these … have broken ground and developed an incredible amount of useful material. So we’ve got a starter kit for regulators.

It’s interesting that SEC Commissioner Alison Herren Lee, when she was acting SEC chair, appointed a climate change adviser. An ESG advisory task force also has been convened. So I think it’s possible that the SEC is getting geared up either way.

Question: Can you talk about how you got to where you are today? Did you hold the same views when starting out at CalPERS that you hold today?

Simpson: I was recruited by CalPERS to be a senior portfolio manager in the global equity portfolio — which is about half of the fund. The conversation at the time was not just about what the fund was doing but what it was that we could or should be doing with the corporate governance program. At the time, the program already had a high profile with a focus list (of equities) and a bit of a name and shame exercise. We also had about $7 billion in a series of specialist corporate governance activist funds…

CalPERS had the headlines. We also had some interesting research showing that the role we were playing was improving valuations of companies, certainly in the short term.

I came to CalPERS with a much broader background on the issue. The first book I wrote was on this topic, commissioned by the Economist and published in 1991. I then wrote this while on maternity leave with my second child. It seemed like a good idea at the time – while the baby was sleeping, right, I would keep myself entertained writing a book. The title of this one was: The Greening of Global Investment: How the Environment, Ethics and Politics are Reshaping Strategies. So I was really on record as someone who was thinking more broadly about these issues.

I also had worked at an investment firm that was set up by public pension funds in the UK to address this broader range of issues. The vision was that investor stewardship was needed not just to protect financial returns but also to address pressing ethical issues, such as British funds’ investment in South Africa (at the time of apartheid). Job creation … and the issue of the real economy was in the mix too along as was the environment of course.  It was a time when there also wasn’t the language that we have now to talk about sustainability and responsible investment.

So I wrote another book, called Fair Shares: The Future of Shareholder Power and Responsibility, which looked at the idea of asset ownership as stewardship and responsibility. The idea was not just to chase returns for private benefit but also to attend to the public good. That was the role of finance in the wider society and the economy.

(Simpson co-wrote the book with Jonathan Charkham, a businessman who advised the Bank of England and who played a key role in setting up systems of corporate governance worldwide with an emphasis on the role of the non-executive, independent board director. He was “very much a grandee of the city of London,” says Simpson.)

So when I came to California (after five years at the World Bank setting up and then leading a project on helping emerging markets work out how to improve access to capital and also as the first Executive Director for the International Corporate Governance Network) CalPERS sort of had a known quantity on their hands.

(Simpson credits the then acting CIO and later CEO at CalPERS Ann Stausboll, who hired her in 2009, with having the vision for the possibilities of a CalPERS sustainability strategy that ultimately could be integrated across all asset classes. She also credits the CalPERS Board of Trustees for their efforts in driving the sustainability agenda.)

Question: I’d like to ask about you, your ambitions and goals as one of the most prominent advocates globally of quality sustainability finance today.  First, there’s your engagement together with other advocates which led to Exxon shareholders’ stunning decision recently to reject the company’s director candidates in favor of three of the four candidates put up by fellow activist travelers. Is this a David and Goliath story — or is there more to it than meets the eye? Is the Exxon vote a bellwether in today’s context?

Simpson: I don’t really view this as a David and Goliath story. The better comparison may be to Spartacus. You know, ‘I am Spartacus’ is every investor who supported the new slate and who stood up to say I’m going to be counted on this. This outcome followed years of engagement with Exxon on the part of large investors. BlackRock, for example, voted against certain board members over their lack of engagement. CalPERS also voted against the Exxon board members.

Prior, investors supported and ran campaigns on issues like majority voting so that we as shareholders would have the ability to vote against director candidates put up by the company. The United Brotherhood of Carpenters had run a proposal on that back in 2016 which almost passed. If investors had not set out to establish these governance rights in earlier years, we wouldn’t be in the position now of being able to remove  corporate candidates for directors and bring forward new ones.

Now the strategy and approach developed and brought forward by Engine One was nothing short of brilliant. They identified Exxon as a company at the tipping point. To their credit, they spent a lot of time in close conversation with large institutional investors like CalPERS making sure that the investment case for change really did resonate with the broader investor community.

Climate Action 100+ also played a role. In my current position as chair, we hosted a webinar so that the four candidates who Engine One put forward could meet with the Climate Action 100+ signatories. So there was the chance to test their credentials and to ask about the dynamics of becoming a shareowner-nominated slate on a board where change is needed.

So the dynamics of the experience in the way the group worked with others was also a part of the conversation. (She noted that Climate Action 100+ extended an invitation to Exxon to also present their candidates but that the oil company declined.)

What is important here is that Engine One had a small stake but brought brilliant expertise and analysis. They also were responsive to institutional investors’ concerns that the new Exxon board include seasoned, experienced directors from the full range of the energy industry…

As I said, this is more of a case of investors stepping up as fiduciaries both to manage risk and to help the company restore its financial fortunes (than it is a David and Goliath story.)


Note: Time ran out before we could get to the unanswered part of the question — what are Simpson’s ambitions and goals going forward. Nevertheless, we can be assured that Simpson is playing a long game and in it for the long-term. She herself describes sustainability finance as a campaign with momentum but still “in the foothills.” Indeed, she and her fellow investment travelers may already be on the mountain. Yes, there’s a way to go — and the path is pointing forward. Callaway Climate Insights says thank you to Simpson and wishes her well.