People will tell you that individual activism and boycotts are a waste of time. Demanding that colleges and universities divest from fossil fuel stocks is for sophomores. Getting arrested outside an ATM machine at a JP Morgan Chase branch in New York City has no impact on things. Don’t believe them. The truth is all those pressure tactics are working — maybe not as fast as we would like, but they are having an effect on the world of finance and investing.
Want proof? Every year, Laurence Fink, the head of BlackRock, the largest asset manager with more than $7 trillion in assets under management, sends a letter to clients outlining his firm’s investment goals and strategies for the coming year. When he speaks, people listen. This year, that letter contained some language that can only be described as a bombshell. Here are the relevant portions of that letter.
Climate change has become a defining factor in companies’ long-term prospects. Last September, when millions of people took to the streets to demand action on climate change, many of them emphasized the significant and lasting impact that it will have on economic growth and prosperity – a risk that markets to date have been slower to reflect. But awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance. (Emphasis original)
The evidence on climate risk is compelling investors to reassess core assumptions about modern finance. Research from a wide range of organizations – including the UN’s Intergovernmental Panel on Climate Change, the BlackRock Investment Institute, and many others, including new studies from McKinsey on the socioeconomic implications of physical climate risk – is deepening our understanding of how climate risk will impact both our physical world and the global system that finances economic growth.
Will cities, for example, be able to afford their infrastructure needs as climate risk reshapes the market for municipal bonds? What will happen to the 30-year mortgage – a key building block of finance – if lenders can’t estimate the impact of climate risk over such a long timeline, and if there is no viable market for flood or fire insurance in impacted areas? What happens to inflation, and in turn interest rates, if the cost of food climbs from drought and flooding? How can we model economic growth if emerging markets see their productivity decline due to extreme heat and other climate impacts?
Investors are increasingly reckoning with these questions and recognizing that climate risk is investment risk. Indeed, climate change is almost invariably the top issue that clients around the world raise with BlackRock. From Europe to Australia, South America to China, Florida to Oregon, investors are asking how they should modify their portfolios. They are seeking to understand both the physical risks associated with climate change as well as the ways that climate policy will impact prices, costs, and demand across the entire economy.
These questions are driving a profound reassessment of risk and asset values. And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself. In the near future – and sooner than most anticipate – there will be a significant reallocation of capital. [Emphasis original.]
An Emphasis On Sustainability
Now, before you break out the champagne, be aware that although Fink is announcing a new set of priorities for BlackRock, he is not stepping away from financing fossil fuels entirely. In fact, natural gas and the means of producing it will still be a significant part of its portfolio. But the shift in emphasis is an important one, in so far as it effectively calls upon the business community to make up for the shortcomings of the present administration.
Over the next few years, one of the most important questions we will face is the scale and scope of government action on climate change, which will generally define the speed with which we move to a low-carbon economy. This challenge cannot be solved without a coordinated, international response from governments, aligned with the goals of the Paris Agreement.
Under any scenario, the energy transition will still take decades. Despite recent rapid advances, the technology does not yet exist to cost-effectively replace many of today’s essential uses of hydrocarbons. We need to be mindful of the economic, scientific, social and political realities of the energy transition. Governments and the private sector must work together to pursue a transition that is both fair and just – we cannot leave behind parts of society, or entire countries in developing markets, as we pursue the path to a low-carbon world.
While government must lead the way in this transition, companies and investors also have a meaningful role to play. As part of this responsibility, BlackRock was a founding member of the Task Force on Climate-related Financial Disclosures (TCFD). We are a signatory to the UN’s Principles for Responsible Investment, and we signed the Vatican’s 2019 statement advocating carbon pricing regimes, which we believe are essential to combating climate change.
BlackRock has joined with France, Germany, and global foundations to establish the Climate Finance Partnership, which is one of several public-private efforts to improve financing mechanisms for infrastructure investment. The need is particularly urgent for cities, because the many components of municipal infrastructure – from roads to sewers to transit – have been built for tolerances and weather conditions that do not align with the new climate reality. In the short term, some of the work to mitigate climate risk could create more economic activity. Yet we are facing the ultimate long-term problem. We don’t yet know which predictions about the climate will be most accurate, nor what effects we have failed to consider. But there is no denying the direction we are heading. Every government, company, and shareholder must confront climate change. (Emphasis original)
Ethics & Transparency
Fink goes into depth regarding his concept of how an ethically managed company should conduct itself.
We believe that all investors, along with regulators, insurers, and the public, need a clearer picture of how companies are managing sustainability-related questions. This data should extend beyond climate to questions around how each company serves its full set of stakeholders, such as the diversity of its workforce, the sustainability of its supply chain, or how well it protects its customers’ data. Each company’s prospects for growth are inextricable from its ability to operate sustainably and serve its full set of stakeholders.
The importance of serving stakeholders and embracing purpose is becoming increasingly central to the way that companies understand their role in society. As I have written in past letters, a company cannot achieve long-term profits without embracing purpose and considering the needs of a broad range of stakeholders. A pharmaceutical company that hikes prices ruthlessly, a mining company that shortchanges safety, a bank that fails to respect its clients – these companies may maximize returns in the short term. But, as we have seen again and again, these actions that damage society will catch up with a company and destroy shareholder value. By contrast, a strong sense of purpose and a commitment to stakeholders helps a company connect more deeply to its customers and adjust to the changing demands of society. Ultimately, purpose is the engine of long-term profitability. [Emphasis original.]
Over time, companies and countries that do not respond to stakeholders and address sustainability risks will encounter growing skepticism from the markets, and in turn, a higher cost of capital. Companies and countries that champion transparency and demonstrate their responsiveness to stakeholders, by contrast, will attract investment more effectively, including higher-quality, more patient capital.
Not Everyone Is Giddy With Joy
The New York Times points out that BlackRock is consistently rated poorly for its performance on climate change and sustainability. It points out that Fink is late to the party and that his newfound concerns for sustainability could have had a major impact on the investment community if they had emerged a decade ago.
He told The Times in an interview that his new perspective developed from conversations with “business leaders and how they’re thinking about it, talking to different scientists, reading different research.” Wherever he goes, he is bombarded with climate questions from investors, often to the exclusion of issues that until recently were once considered more important. When he asked his company’s own research department to look into those concerns, he was advised that many municipalities are paying higher insurance premiums due to greater risk brought about by climate change.
One reason people criticize BlackRock is because it has largely failed to use its financial muscle to support shareholder initiatives that seek to force major corporations to give greater weight to the threat of climate change in their management decisions. Fink says that is about to change.
We will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.
A Turning Point
It’s not all blue skies and rainbows, but it could be an important turning point in how the financial world thinks about climate change. As The Times points out, the heads of every major business corporation in the world got a copy of Fink’s letter. What he wrote will have an impact on the thinking that goes on inside boardrooms all across the world. And that is reason enough to say thank you to Greta Thunberg and the millions of young people all over the world who have taken to the streets in recent years to force the business community to take climate change seriously.
Change happens slowly in the world of finance. But once it begins, it can proceed quickly. And anything that offsets the horrors of the Trump maladministration has to be welcome news. Fink says none of this is about politics, only sound financial management. Yet the two are inextricably intertwined. America should be leading the campaign to address climate change in a meaningful way. Perhaps the words of Laurence Fink will begin to make that happen.