From the overarching climate-change debate to specific arguments on the effectiveness of ESG factor integration in policy setting or investment decisions, we always get confronted with the transition versus transformation narrative. A first message is that both are not mutually exclusive. In this brief piece, we ask ourselves how we should look at both in the context of today’s environmental and social challenges. And what type of governance is required across transition and transformation?
We acknowledge that, in order to obtain sustainable societal change, both are required. Transition and transformation have in common that they embed systemic dimensions. A dimension where complex, adaptive systems are at work.
Transition is geared towards specific sub-systems such as energy, mobility, production processes… whereas transformation is geared towards large-scale societal change processes, relying on innovative government policies and corporate business models within a global, regional or local context. In transformation, we express and detect long-term impact as social and ecological interactions that enduringly alter outcomes. Outcomes that neutralise or minimise negative externalities.
The processes running across transition and transformation are path-dependent, whilst adhering to a set of criteria and or thresholds. Transition processes provide an answer to ‘how the change path evolves’. Transformation zooms in on outcomes or ‘which new patterns of collaboration, entrepreneurship, government policies emerge in order to intentionally reach certain (new or better) outcomes’. For completeness, both transitions and transformations can also fail, resulting in respectively narrow or more broad-based negative externalities.
The towards net-zero transition ambitions across many asset managers, asset owners or banking institutions spring to mind. Investments in government paper, company debt, equity or mortgage instruments, all require an assessment framework in order to define, track and measure how and by when certain greenhouse gas emission targets will be reached. Such processes require standardisation as well as common measurement definitions and techniques in order to set quality criteria or thresholds over short time horizons i.e., between today and 5-to-10-years out. To make things more complicated, these will also differ across industries and sectors.
Identifying the dynamic processes that deal with transformative change is less evident. Transformation processes coalesce around regeneration (renewal, restoration or refitting business models that apply an economic circularity dimension), clean air (transformative carbon removal solutions) or clean water. Transformative solutions change the original system conditions in which we are used to operate. Through bold research and development, government organisations or private companies (or a combination thereof) aspire to reach positive tipping points away from traditional extraction-based solutions that impact the planet and its people negatively.
For asset managers it is paramount to monitor transition paths. OK, companies and governments that remain close to the pledged transition path will become inherently less risky and investment will become less volatile. However, identifying investment targets (more related to private companies than the government level) that embed transformative business-model changes can achieve higher financial as well as non-financial benefits. Detecting the longer-term – over 10 to 20 years – visionary, organisational and global systemic transformations is the name of the game. These transformations run alongside urban mobility, health and quality of life.
Water solutions, biodiversity ingenuity and land use/soil management open up another box of transformative business models. Today, energy, global agriculture and food systems get most of our attention given the reality of war and embarrassing geopolitical tensions.
Astute asset managers will have identified and invested in companies that already – successfully (through quality earnings and robust balance sheets) – provide products and services with a transformative impact. We call these enabling companies. Robust equity and credit portfolios will also hold challenger companies whose business models will transform over a 10-to-20-year horizon. Enabling and challenger companies will need to overcome multiple trade-offs between economic, environmental and social objectives. They should receive objective impact measurement assessments across products & services (from a revenue but by extension also on the opex and capex perspective). Impact measurement can occur across various frameworks. Impact measurement against UN SDG objectives becomes well-established in public markets. Private markets developed similar high-quality impact models. Increased exchanges across public and private market participants will lead to better outcomes. Another transformation in the making.
The governance framework leading to transition success, whilst leveraging transformation potential, is built on innovation, learning & knowledge integration but above all collaboration. Disruptive (and regulatory) interventions support sustainable transitions. Transformation requires alignment of individual and societal motives and desired outcomes. In a sense, transformation is built on the theory of change. What are the outcomes we want to achieve and what path can we design in order to get us there?
I hope this short note provides inspiration to reflect on the similarities and differences of transition versus transformation. Identifying the contours of companies and governments that allow for successful transformation has important value. You will learn that they typically will be able to balance interests rather than align interests. Alignment reveals ranking and prioritisation. Balance reveals optimal outcomes across stakeholders.
