When it comes to taking action on climate change, the world has entered a very strange place. Scientific results continue to indicate that the consensus about our role in driving climate change has every reason to be accepted. Several years of the predicted impacts of climate change — record high temperatures, massive storms, and out-of-control wildfires — have increasingly left the public ignoring the few remaining skeptics and deniers. Apart from a handful of reluctance, governments have accepted that they must do something about climate change.
Despite all that, we are still doing very little and carbon emissions have continued to rise. Nowhere is this more obvious than in the financial markets. It is abundantly clear that companies are placing value on extraction rights from fossil fuel deposits, even though governments will almost certainly block the development of some of them. And they continue to do so because governments and investors allow them to.
Divestment campaigns have begun to change that, causing $12 trillion in assets to be withdrawn from companies that rely on fossil fuels. But the movement may have gained significant additional momentum this week, as one of the biggest investment firms, BlackRock, announced that it will make sustainability, and climate change in particular, central to its strategies. Included in his announcement is that he would immediately begin unwinding many coal investments and complete the turnaround before the year is out.
What BlackRock can and cannot do
BlackRock’s new policy was announced in to an open letter from its CEO to the companies it invests in (or could invest in). The consequences of that policy were elaborated by an accompanying letter from its management team to its investors. We will spend some time on the details of this policy and why below. But first we’ll explain why BlackRock’s decision is important and a number of factors that may limit its overall impact.
One key to the importance of the decision is simply the scale of the company: BlackRock manages roughly $7 trillion in assets, investing money on behalf of institutional investors and individuals. From a purely PR perspective, a company of that size that focuses on sustainability puts pressure on other investment firms to follow, so that they are not seen as poor global citizens. But BlackRock’s announcements also make a strong case that focusing on sustainability is a powerful tool for avoiding financial risk. If other investors find these arguments convincing, then other companies could be forced to follow suit.
In managing the money that investors have invested, BlackRock and these other companies are subject to “fiduciary duty,” meaning that they must act in the best interests of their investors. Effectively, this means that the company has to argue that changes in your investment strategy represent good financial decision making.
However, BlackRock’s ability to act is limited by the nature of some of the things it offers investors. The assets are often invested in specific funds aimed at identifying the best performing companies in specific markets, such as health care or energy. Here, BlackRock can do a number of things: change its definition of best performance to include sustainability metrics; offer funds that focus on companies that have sustainable business models; and offering funds that invest in specific sustainable businesses, such as renewable energy.
However, many of the assets BlackRock manages are invested in passively managed index funds, which put their money in companies that fit a specific definition: all S&P 500 companies, or all stocks that fit a definition of “small cap”. for instance. Here, regardless of BlackRock’s focus on sustainability, there is little the company can do to change the companies in which it invests.
However, BlackRock can potentially change the companies themselves. Investors in these funds typically grant investment managers the ability to act as proxy votes on the governance of the company. These include things like approving members of the company’s board of directors or changing the way the company does business. Due to the fact that major investors like BlackRock own a large number of shares, changes in their voting patterns can make a substantial difference.
what do you plan to do
With a better idea of what the company can do, we can move on to what it plans to do. In open letters, company management makes its case for a focus on sustainability.
“BlackRock doesn’t see itself as a passive observer in the low-carbon transition,” argues CEO Larry Fink. “We believe we have an important responsibility, as an index fund provider, as a trustee and as a member of society, to play a constructive role in the transition.” And, just as significantly, Fink says, clients have consistently asked for action on climate and sustainability issues.
Fink goes on to explain how sustainability fits in with the company’s fiduciary duty. He argues that “climate change has become a determining factor in the long-term prospects of companies.” As a result, investors are beginning to “re-evaluate core assumptions about modern finance,” which will mean that “in the near future, and sooner than most anticipate, there will be a major reallocation of capital.” Because of this impending reallocation, companies that focus on sustainability provide the lowest risk and best returns for investment, Fink argues. This provides the rationale for changing investment policies to protect the interests of their investors.
BlackRock CEO calls on companies to use newly developed standards to report on their climate and sustainability-related risks, as well as how they plan to operate within the limits set by the Paris Climate Agreement. He goes on to state that if companies don’t do this, BlackRock will assume they are not managing risks properly. He then drops the big threat: “We will be increasingly willing to vote against management and directors when companies are not making enough progress on sustainability-related disclosures and underlying business practices and plans.”
The letter from the company’s Executive Committee provides details on some of the practical changes that will be made. For funds that are actively managed, sustainable alternatives will be developed and ultimately become the central focus of the company. For unmanaged index funds, the company will develop alternatives that have a similar focus and investment returns, but include only companies that meet its sustainability standards. All fund managers will be required to report on how they are managing sustainability risks, and the company will develop tools to better assess them. The results of those evaluations will be used internally and provided to potential investors as part of the fund’s advertising and disclosures.
As a first step in limiting the company’s exposure to climate risks, it is focusing on coal. “Thermal coal is significantly carbon intensive, becoming less and less economically viable, and highly exposed to regulation due to its environmental impacts,” BlackRock executives argue. “With the global energy transition accelerating, we do not believe the long-term economic or investment rationale warrants continued investment in this sector.” Before the end of 2020, the company will sell investments in any company that derives more than a quarter of its revenue from coal production.
That leaves plenty of room for continued investment in diversified companies where coal is only part of their revenue. But those are also the companies that are best positioned to exit the market as their prospects grow increasingly bleak.
good but not good enough
While most of the individual steps BlackRock is taking are commendable, the full extent of their impact will be determined by how many additional companies the decision forces to follow suit and how quickly companies move to adopt BlackRock’s risk standards. . The challenges here are substantial and are nicely reflected in another recent open letter from a corporate CEO.
East It came from Siemens CEO Joe Kaeser, who was responding to criticism of the company’s role in a coal mining project in Australia, criticism that has increased in the wake of the country’s wildfire season. Siemens’ role in the project is small: it is supplying signaling equipment for the railway that will serve the mine, but its involvement is jarring given that the company has pledged to be carbon neutral within a decade.
The letter is a strange mix of justifications and confusing messages. We signed a contract and we cannot back down. But we have modified the contract so that we can back out if bad things happen. The Australian government and local native Australians approved it, so that’s fine. And other companies were bidding on the contract that we won, so it would have happened anyway. We love the environment, but we also love our workers and we wanted to make sure we didn’t lose money on this. But caring for the environment should not be a question of money. We want Greta and other teens involved to approve of our actions, but they keep saying no. Did I mention that we have a large renewable energy division? We will also help with wildfire recovery.
(No, I’m not exaggerating. All of the above, plus a specific mention of Greta Thunberg, is there.)
It takes Kaeser until the last paragraph of the letter to get to the real issue: “We should have been wiser about this project beforehand.” In other words, our commitment to managing climate change is not deep enough to have changed the way the company makes business decisions. That deep-seated tendency to continue business as usual is exactly how we ended up doing so little despite public consensus to act, and it represents the biggest challenge BlackRock will face.