Practical analysis for investment professionals
23 August 2023

Climate Change, Risk Management, and the Freedom to Invest Responsibly

Risk management is so simple a concept and so central to financial analysis that it feels superfluous to even mention it. Yet when it comes to climate change and sustainability, efforts are under way across the United States to impede our ability as investors to conduct simple risk management. Policymakers have proposed and even passed laws that make it more difficult, if not illegal, for investors to consider the financial risks of climate change.

These efforts are misguided. The freedom to invest responsibly and the principle of risk management must be defended, and that requires us to go back to basics.

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Does climate change pose financial risk? The answer is clear. Drought, heat waves, and extreme weather all exact a signficant toll from infrastructure, supply chains, facilities, and people. Indeed, the United States recorded $165 billion in losses from climate disasters just last year. But the climate crisis also presents enormous opportunity. The Inflation Reduction Act has driven a clean energy boom across the country. Investors should not have to sit it out.

Informed by these facts, investors have increasingly integrated climate considerations into their decision making precisely because the financial effects are so clear. They are acting on sound, rational logic, and governments should not interfere with that process.

Yet some states have instituted new laws forbidding investors from taking climate change impacts into account when assessing bond issuances, pension fund management, and other government contracts. In effect, they are penalizing risk management.

Ignoring a financial risk does not make it go away; it only makes it worse. Whether on individual balance sheets or across a national economy, failing to account for and address potential threats has a significant downside. Investors need data to assess these risks and the freedom to act on that data based on their business considerations. Their fiduciary duty requires it.

When investors lack these essentials, markets are less efficient and less effective, and everyone invested in those markets suffers. If there are fewer financial institutions competing in the marketplace, states will be forced to pay millions more in extra interest payments. And if states work only with institutions that do not consider climate- and sustainability-related risks, they will expose their pension funds, beneficiaries, and taxpayers to the downsides of those risks.

Most investors understand the threat and are responding as they should: by studying the data, following the trends, and keeping a watchful eye out for risks and opportunities. But being rational market actors isn’t enough.

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That’s why investors and private and public sector leaders have joined together to urge policymakers to protect every investor’s right to incorporate climate and sustainability risks into their decision making. They are making a clear statement that executing their fiduciary duty should not be subject to government interference. Such interference will only make it harder for them to do their jobs and serve their clients.

That is why we all need to stand up, speak out, and demand the freedom to invest responsibly.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / trekandshoot

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About the Author(s)
Steven Rothstein

Steven Rothstein is the managing director of the Ceres Accelerator for Sustainable Capital Markets at Ceres.

2 thoughts on “Climate Change, Risk Management, and the Freedom to Invest Responsibly”

  1. Chris Macon says:

    ESG will always be too subjective to be taken seriously. These states are ahead of their time by not allowing flavor of the week agendas and narratives to affect the well-being of their investments. Who is to say that a company that stimulates excess consumption like Google is more ESG than Exxon that has no control of their demand?

    Truth doesn’t require belief, it will take care of itself.

  2. Ian Robertson says:

    Thank you Steven Rothstein for a thoughtful and well articulated article. The integration of financially material ESG considerations into security valuation and risk management is entirely consistent with investment professionals’ fiduciary duty and with well-functioning capital markets.

    The first challenge that arises with discussion about ESG issues is the different definitions or perspectives adopted by discussants. Some take the perspective of this article – ESG data can contain important information that is not reflected on traditional financial statements – while others view ESG issues as morals-based assessments used to screen companies from portfolios. The first perspective was codified by the UN-backed Principles for Responsible Investment in 2006 (though its practice predates the PRI), while the second is much older and has roots in religious, ethical, and values-based screening and in the Socially Responsible Investing heyday of the 1960s, 1970s and 1980s. The PRI’s approach is entirely consistent with traditional financial analysis; the SRI approach is more in line with behavioural finance. There is an excellent and up-to-date summary of these divergent ‘valuation’ vs. ‘values’ perspectives in Laura Starks’ presidential address to the American Finance Association and published in The Journal of Finance (

    The second challenge that arises is one of materiality, time horizon, and cost. The financial materiality of an ESG issue can change with time horizon; what is material to an investor with a short time horizon (e.g., hedge fund) may be much different that to an investor with a very long time horizon (e.g., pension fund). The US has historically taken a middle of road approach to time horizon for materiality, using a ‘reasonable person’ test for utility. This brings the cost issue to the forefront, both for investors as they integrate the sometimes inchoate data needed for more accurate risk assessments, and for issuers as they provide the data in the first place.

    The balancing of materiality and cost has forever underpinned active management and the pursuit of alpha. The nature of many ESG issues connects alpha to CFA Institute’s mission and vision, and its leadership of the investment profession for ‘the ultimate benefit of society’.

    Prohibiting the use of ESG information does not appear to be consistent with well-functioning markets given its growing financial materiality. As US SEC commissioner Allison Herron Lee (2021) noted in a speech, the fact that an ESG issue may have a political dimension does not preclude it from being financially material. To this I would add that investors should also feel welcome to use ESG information for values-based decisions – it has always been the right of investors to include or exclude securities they ‘like’ or ‘dislike’ (though in theory they are transferring wealth to non values-based investors) – but the fact that some investors do so should not preclude the rest of the market participants using material ESG information in their analysis.

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