The world’s largest asset manager sent a clear message to CEOs with his annual letter this week. Implement sustainability measures or face the consequences. The letter is direct in its title, “A Fundamental Reshaping of Finance”, and in it Larry Fink claims climate change will cause a transformative reallocation of capital towards sustainable investments. “Awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance” he writes.
BlackRock is preparing for these changes. It’s incorporating Environmental, Social and Governance (ESG) metrics in its investment strategies. What’s more, the company is encouraging businesses to disclose these measures. BlackRock will also develop investment funds focused on sustainable business decisions.
Social entrepreneurs, environmental advocates and conscious consumers are praising Fink’s definitive stance. Some investment veterans disagree. Warren Buffett criticized his public statement for being politicized. Regardless of how you feel about it, there is a shift in society and finance. Milton Friedman’s long-standing views that a business’ sole purpose should be to generate profit for shareholders are being challenged.
Last year, CEO’s from some of the world’s largest corporations like Apple, JP Morgan Chase and Walmart gathered at the Business Roundtable. They agreed and announced in a joint Statement on the Purpose of a Corporation that companies should work to benefit employees, the environment and suppliers. What’s more, today’s consumers, especially millennials, are looking to support conscious businesses. As millennials inherit the world’s wealth and assume leadership positions within companies, their values will influence global financial trends.
There’s no denying that climate change and related governance issues will shift the long-term business environment. Forward-thinking business leaders are taking measures now to be ahead of the game to ensure their own survival, relevance and impact in the future. They are putting purpose first to position themselves to be the leading brands of tomorrow.
Here are top takeaways from Larry Fink’s annual letter that every company must consider.
● “Climate risk is investment risk.”
Associated financial risks go beyond the dangers of hurricanes impacting 30-year mortgage rates. They are greater than risks of flooding boosting the price of the global price of food. Climate policy poses a risk to every industry with a large environmental footprint. And while the U.S. withdrew from the Paris Climate Agreement, the rest of the world is still committed and a shift in political power could reroute the U.S. to enact policies in line with the accord.
“Climate change is almost invariably the top issue that clients around the world raise with BlackRock,” Fink writes. While climate impacts can take decades or longer to take full effect, shifts in financial markets can happen overnight. As such, companies that prepare for climate disasters, mitigate emissions and invest in sustainable practices are better prepared for uncertainty and instability.
● Uncertainty is certain.
This goes for both the impact of climate change and climate policy. “We don’t yet know which predictions about the climate will be most accurate, nor what effects we have failed to consider,” BlackRock’s CEO states. “But there is no denying the direction we are heading. Every government, company, and shareholder must confront climate change.” This is not a business or political issue, but rather a challenge to humanity on a scale previously unseen. As such, it cannot be treated as someone else’s problem. Nor can we continue to kick the can down the road. The reality and devastating impact of the climate crisis is here, and every company has a responsibility to reengineer their practices for their own sake and for our future.
● “There will be a significant reallocation of capital.”
There’s increased investor awareness and sensitivity to climate risk. Shareholders are considering changes to 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.”
“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,” Fink predicts. This will dramatically affect the expectations of investors, shareholders, customers and consumers, which in turn will have public consequences for leadership and companies that fail to respond and behave in ways that reflect the reality of today’s marketplace and planet.
● Companies & investors must act:
Governments are the leading force behind climate policy change. We also need businesses and investors to step up to the plate. If we are going to meet the 2-degree climate targets set out in the Paris Agreement, we need all hands on deck.
● Sustainability reduces risk:
Companies that practice social and environmental stewardship prepare for climate and governance risks. While over-exploiting natural resources might yield high short-term profits, in the long run responsible capitalism will lead the way to long-term financial returns.
“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,” Fink claims. To that end, there is not only investor downside to continuing long-standing exploitative practices, but there will be missed rewards for those companies that fail to recognize investor willingness to support companies that are solving for issues directly affecting people’s lives.
● We need uniform sustainability metrics:
You can’t change what you can’t measure. BlackRock is a founder of the Force on Climate-related Financial Disclosures (TCFD). The TCFD helps quantify climate and governance risks. The financial powerhouse also advocates for the Sustainability Accounting Standards Board (SASB) standards.
BlackRock is working on its own disclosure. The company’s SASB reporting is available on its website and TCFD will be disclosed by the end of this year. The asset manager is also requesting that companies it invests in make disclosures as well. By working with the TCFD and SASB framework, BlackRock can better assess sustainability, ethics and climate risk data.
“In the absence of robust disclosures, investors, including BlackRock, will increasingly conclude that companies are not adequately managing risk,” Fink writes in his letter. The time for good intentions or purpose-washing has passed. Companies must create meaningful and measurable impact that makes them defensible and competitive in a marketplace increasingly defined by a challenged planet.
● Transparency is paramount:
Fink argues that a company’s growth prospects are correlated to its ability to benefit its stakeholders. This is essential to investor decision-making. To be able to assess a company’s ability to serve its stakeholders, investors need information.
“Disclosure should be a means to achieving a more sustainable and inclusive capitalism,” Fink writes. BlackRock is working to liberalize information. The fund manager will publish a company’s carbon footprint and other sustainability metrics this year. Investors will be better prepared to make decisions that align with their values and long-term financial goals.
● Purpose is critical to long term success:
Capital markets are beginning to internalize the negative externalities of unsustainable business. In turn, cheaper capital will be available for purpose-driven companies. Companies that disregard people and the planet will face greater difficulty raising capital. This will also funnel into business opportunities and long-term prospects. Companies that work to build a better world will gain more support and momentum over time.
“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,” Fink writes. “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.”
The future of profit is purpose and Larry Fink’s 3rd Annual letter makes a compelling case for shifts that will remake the capital markets. Smart and responsible leaders and companies will recognize these environmental and market forces and will retool how they do business with transparency and accountability. Those that don’t will have no one to blame but themselves.