“A Fundamental Reshaping of Finance”: My annotated version of Larry Fink’s Bombshell CEO Letter

(I just posted yesterday and I generally only do a couple of posts per month, but there was some big sustainability news that I wanted everyone to know about)

Larry Fink is the CEO of Blackrock, the largest asset manager in the world, with more than $7 trillion under management. Every year in January, Fink writes a public letter to the CEOs of the world’s largest companies. For the last 5 years, he has made the case for long-term thinking and sustainability. In 2016, he said that the “culture of quarterly earnings hysteria is totally contrary to the long-term approach we need.” By 2018, he was hitting hard on the idea of purpose and last year declared that “Purpose is…a company’s fundamental reason for being – what it does every day to create value for its stakeholders. Purpose is not the sole pursuit of profits but the animating force for achieving them.”

It was powerful stuff. The way he’s framed the shifting definition of value creation, to include long-term thinking and pressing societal issues, has been important. But it hasn’t been clear how much CEOs were swayed by the sentiments, especially since Blackrock had a spotty record of actually backing up the rhetoric with votes on shareholder resolutions on environmental or social issues. But this year’s letter goes much further. Fink makes the case that climate change will fundamentally reshape the world and finance.

For a quick take on his letter (which is definitely worth a thorough reading), I’ve annotated it with my thoughts below. The text I’m focusing on is in italics and my comments are in bold and brackets…

A Fundamental Reshaping of Finance

Dear CEO,

As an asset manager, BlackRock invests on behalf of others, and I am writing to you as an advisor and fiduciary to these clients. [For many years, investors have said they can’t pursue sustainable investing because of their fiduciary responsibility — the assumption being that sustainability is not profitable. Fink has been tearing that idea down for years. He’s clearly indicating that everything he’s about to say is precisely because of his fiduciary responsibility.] 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. [A bold statement, and i’d go further and say that climate change is fast becoming the defining factor for company and human 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[I’m not sure how many in finance have really questioned core assumptions yet, but this letter will kick off some tough conversations.] 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? [The business community, and finance in particular, has never quite grappled with the reality that environment is not a niche issue within business — it’s the other way around, with the economy being a subsidiary of a functioning planet. He’s getting very close to that level of connection here by pointing out in concrete terms what happens to insurance and bonds in areas hit by extreme weather. Put more simply, if/when a place like Miami is under water, it won’t have a very good economy, and many years before that point, a 30-year mortgage there is a very bad idea.]

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. [In my anecdotal experience in the last year or two, this issue — the pressure from customers, especially private wealth clients — has greatly increased the focus of the financial world on climate. Consumers are asking, so banks are responding.] 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. [This is such a strong and important conclusion. “Sooner than most anticipate” is almost a threat. So think about what he’s really saying here. If there’s a significant move of capital away from fossils to renewables, away from property in unlivable areas, and so on, the winners will move early. Late adopters will suffer and lose their shirts.]

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. [These statements even surprise me. There’s been so much debate about whether ESG or sustainable investments ‘outperform’, it’s rare to see a big investor say flat out that managing sustainability and climate issues is a better investment strategy]

In a letter to our clients today [please go read the letter — i won’t annotate that today, but it’s got a LOT to unpack in terms of commitments the company is making to build a world of finance that’s compatible with a thriving world], 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. [A strong commitment to global governance and government, not usually a comfortable statement from investors. He’s recognizing that this problem is far too big to leave to magical free markets. We need significant tools of government, like carbon pricing, to scale up quickly.]

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.[This whole section is an interesting addition to his climate pitch. He’s making the broader argument for managing a business with multiple stakeholders in mind, not solely investors. This is in line with the Business Roundtable Statement last August. But of course it’s novel to see an investor — and the world’s largest — argue against shareholder primacy.]

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, [This raises the bar on transparency and demands that companies open up about climate risks and opportunities.] 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.[This could be a big deal. Blackrock has not leveraged its power to truly support ESG resolutions or really pressure management. If they back this up, it’s powerful. Blackrock owns a noticeable percentage of every large company. In this statement, he’s threatening to push out corporate execs who don’t get it.] 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.

Accountable and Transparent Capitalism

Over the 40 years of my career in finance, I have witnessed a number of financial crises and challenges – the inflation spikes of the 1970s and early 1980s, the Asian currency crisis in 1997, the dot-com bubble, and the global financial crisis. Even when these episodes lasted for many years, they were all, in the broad scheme of things, short-term in nature. Climate change is different. Even if only a fraction of the projected impacts is realized, this is a much more structural, long-term crisis. Companies, investors, and governments must prepare for a significant reallocation of capital. [And here’s the big stuff — ‘climate change is different’. Most definitely. He’s making the case that we don’t actually have to have all of the climate impacts fully mapped out to act. The risk is so large now, that as he says ‘if only a fraction’ comes to pass, it’s devastating and very expensive. So again, he says, we will reallocate capital.]

In the discussions BlackRock has with clients around the world, more and more of them are looking to reallocate their capital into sustainable strategies. If ten percent of global investors do so – or even five percent – we will witness massive capital shifts. And this dynamic will accelerate as the next generation takes the helm of government and business. [Megatrend alert. This letter hits all the big pressures that I spend my time and work focusing on and writing about. Climate, transparency, role of business in society, and of course, generational shifts in expectations. As Millennials and Gen Z ‘take the helm’, and inherit wealth from boomers, the pressure on investors will only rise.] Young people have been at the forefront of calling on institutions – including BlackRock – to address the new challenges associated with climate change. They are asking more of companies and of governments, in both transparency and in action. And as trillions of dollars shift to millennials over the next few decades, as they become CEOs and CIOs, as they become the policymakers and heads of state, they will further reshape the world’s approach to sustainability.

As we approach a period of significant capital reallocation, companies have a responsibility – and an economic imperative – to give shareholders a clear picture of their preparedness. And in the future, greater transparency on questions of sustainability will be a persistently important component of every company’s ability to attract capital. [An interesting repercussion of the transparency drive — those that don’t embrace it will not get capital] It will help investors assess which companies are serving their stakeholders effectively, reshaping the flow of capital accordingly. But the goal cannot be transparency for transparency’s sake. Disclosure should be a means to achieving a more sustainable and inclusive capitalism. Companies must be deliberate and committed to embracing purpose and serving all stakeholders – your shareholders, customers, employees, and the communities where you operate. In doing so, your company will enjoy greater long-term prosperity, as will investors, workers, and society as a whole.


Larry Fink, Chairman and Chief Executive Officer

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