BlackRock Flips Its Script on ESG?

George Hay of Reuters reports that Larry Fink is slowly becoming part of climate solution:
Larry Fink seems to be listening to his critics. The BlackRock boss on Tuesday published his annual letter to CEOs of the companies the $7 trillion fund manager invests in. To a greater degree than in the past, tackling climate change is the priority.

Fink might argue that previous letters, which called for companies to help stakeholders as well as shareholders, were on a similar path. BlackRock is no stranger to applying environmental, social and governance criteria to its investment processes. But its public record on pushing companies to tackle global warming has been criticised by activists, who point out that its funds vote against most climate-related resolutions.

Fink’s letter flips the script in multiple ways. BlackRock now sees sustainable investing as the “strongest foundation” for client portfolios, rather than lowering potential investment returns. It also flags the dangers of financial markets repricing climate-related risks sooner rather than later. By mid-2020, the firm’s active fund managers will therefore stop investing in groups that generate over a quarter of their revenue from thermal coal production.

This is welcome, but hardly revolutionary. BlackRock funds will still own shares and bonds of carbon-emitting oil and gas companies. The company also sees 2 degrees Celsius of warming from pre-industrial levels as the danger point, rather than the 1.5 degrees Celsius many scientists say is a big problem. And only a quarter of BlackRock’s assets are actively managed. The majority are passive index-trackers which cannot selectively sell securities.

Fink’s most eye-catching shift is therefore to change how BlackRock plans to engage with the companies it invests in, whether active or passive. From now on, it will be “increasingly disposed” to vote against directors at companies that are not doing enough. That includes those like Exxon Mobil which lobbyist CDP argues have been slow to explain how their balance sheets would be affected by higher temperatures.

BlackRock itself is evidence of what such a change can achieve. Fink’s greater focus on climate change owes much to the firm’s own clients – such as Japan’s huge Government Pension Investment Fund – shoving it in this direction. If Fink is serious about applying the same pressure on the companies BlackRock invests in, his 2020 letter may be seen as a watershed.
I think it's worth reading Larry Fink's letter to CEOs:
As an asset manager, BlackRock invests on behalf of others, and I am writing to you as an advisor and fiduciary to these clients. The money we manage is not our own. It belongs to people in dozens of countries trying to finance long-term goals like retirement. And we have a deep responsibility to these institutions and individuals – who are shareholders in your company and thousands of others – to promote long-term value.

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.

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.

Climate Risk Is Investment Risk

As a fiduciary, our responsibility is to help clients navigate this transition. Our investment conviction is that sustainability- and climate-integrated portfolios can provide better risk-adjusted returns to investors. And with the impact of sustainability on investment returns increasing, we believe that sustainable investing is the strongest foundation for client portfolios going forward.

In a letter to our clients today, BlackRock announced a number of initiatives to place sustainability at the center of our investment approach, including: making sustainability integral to portfolio construction and risk management; exiting investments that present a high sustainability-related risk, such as thermal coal producers; launching new investment products that screen fossil fuels; and strengthening our commitment to sustainability and transparency in our investment stewardship activities.

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.

Improved Disclosure for Shareholders

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.

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.

Important progress improving disclosure has already been made – and many companies already do an exemplary job of integrating and reporting on sustainability – but we need to achieve more widespread and standardized adoption. While no framework is perfect, BlackRock believes that the Sustainability Accounting Standards Board (SASB) provides a clear set of standards for reporting sustainability information across a wide range of issues, from labor practices to data privacy to business ethics. For evaluating and reporting climate-related risks, as well as the related governance issues that are essential to managing them, the TCFD provides a valuable framework.

We recognize that reporting to these standards requires significant time, analysis, and effort. BlackRock itself is not yet where we want to be, and we are continuously working to improve our own reporting. Our SASB-aligned disclosure is available on our website, and we will be releasing a TCFD-aligned disclosure by the end of 2020.

BlackRock has been engaging with companies for several years on their progress towards TCFD- and SASB-aligned reporting. This year, we are asking the companies that we invest in on behalf of our clients to: (1) publish a disclosure in line with industry-specific SASB guidelines by year-end, if you have not already done so, or disclose a similar set of data in a way that is relevant to your particular business; and (2) disclose climate-related risks in line with the TCFD’s recommendations, if you have not already done so. This should include your plan for operating under a scenario where the Paris Agreement’s goal of limiting global warming to less than two degrees is fully realized, as expressed by the TCFD guidelines.

We will use these disclosures and our engagements to ascertain whether companies are properly managing and overseeing these risks within their business and adequately planning for the future. In the absence of robust disclosures, investors, including BlackRock, will increasingly conclude that companies are not adequately managing risk.

We believe that when a company is not effectively addressing a material issue, its directors should be held accountable. Last year BlackRock voted against or withheld votes from 4,800 directors at 2,700 different companies. Where we feel companies and boards are not producing effective sustainability disclosures or implementing frameworks for managing these issues, we will hold board members accountable. Given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, 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.
The two key proposals Larry Fink is asking companies they invest in on behalf of clients are:
  1. Publish a disclosure in line with industry-specific SASB guidelines by year-end, if you have not already done so, or disclose a similar set of data in a way that is relevant to your particular business; and
  2. Disclose climate-related risks in line with the TCFD’s recommendations, if you have not already done so.
Now, if I were a fiduciary or even a company which is studying these proposals, I'd hire a bunch of expert consultants to really understand how to implement these proposals in a seamless fashion.

And I'm not just talking about big accounting firms but also smaller boutique shops like Mantle314 which lives and breathes climate risks and solutions.

In fact, Joy Williams, a senior advisor at Mantle314, helped the New York State Common Retirement Fund (NYSCRF) write its Climate Action Plan which it released last year. You can read her remarks to the New York Senate Standing Committee on Finance here.

All over the world, big pensions and sovereign wealth funds are trying to address the risks and opportunities of climate change.

In Canada, our large pensions have significantly bolstered their responsible investing activities across public and private markets but more needs to be done as this is work in progress.

ESG is the flavour of the day and BlackRock was late to the party. As the world's largest asset manager, it needs to do a lot more to be a leader in this field and that's what Larry Fink is stating in black and white.

BlackRock can no longer ignore what companies it invests in are doing when it comes to climate risk. Just like large pensions and sovereign wealth funds, it needs to engage corporations it invests in and use its proxy voting power to influence and change outcomes.

Of course, BlackRock has been criticized for a very long time and rightfully so. It comes with the territory but keep in mind, the same ESG principles need to be applied to private companies as well.

I've already covered Canada's Final Report on Sustainable Finance as well as Barb Zvan and Kim Thomassin's keynote address at the Quebec & Atlantic CAIP conference last year.

Now we are at a point where things need to be standardized and implemented across public and private markets. This implementation phase isn't easy but it's the most important part.

What worries me discussing ESG issues with some experts is that large investment funds are talking the talk but not walking the walk yet, especially the S & G part of ESG.

Also, I'm concerned that in private equity, the real experts in sustainable finance are often being overlooked for larger "brand name" funds who are new to the game. It's disheartening when a fund manager tells me "we didn't fit in one of their buckets" (I roll my eyes and tell them: "Ah, those damn buckets!!".

Lastly, I'm a bit worried about an ESG bubble in public markets and even more worried about public outcry influencing pensions to make dumb decisions, like divesting from fossil fuel.

Luckily, most pensions take their fiduciary duty very seriously so I was happy to read that CalSTRS rejected a proposal to divest from fossil fuel:

When it comes to fossil fuel companies, engage with them, don't dump them!

By the way, someone told me yesterday if Shell, BP, Exxon Mobil, Chevron and other oil giants only fractionally moved to invest more in renewable energy and innovative technology companies transforming energy usage, "they'd swamp pensions."

Unfortunately, someone else told me that “corporate bureaucracy is just as bad as public sector bureaucracy" and many senior managers at large corporations aren't willing to take risks, "they just want to coast by and retire with a nice package."

Below, Larry Fink, founder and CEO of the world's largest asset manager who oversees nearly $7 trillion at BlackRock, announced in his annual letter that BlackRock will make investment decisions with environmental sustainability as its core goal. He sat down with CNBC's Andrew Ross Sorkin to discuss what went through his mind when writing this year's letter. Sorkin also reported on his interview with BlackRock CEO Larry Fink on "Closing Bell."

Lastly, CNBC's Bob Pisani looked ahead at the day's market action at the open today and spoke about BlackRock doubling its ESG ETF offerings and offering sustainable flagship index products. Pisani also discusses how even though ESG investing makes up a small part of the ETF universe, it’s growing fast.