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Major investment firm to prioritize sustainability, back off coal

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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 on 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 left ever more of the public ignoring the few skeptics and denialists who persist. Aside from a handful of holdouts, governments have accepted that they need to do something about climate change.

Despite all that, we continue to do very little, and carbon emissions have continued to rise. Nowhere is this more obvious than in the financial markets. It's very clear that companies are assigning value to the rights to extract fossil fuels deposits, even though governments will almost certainly block some of them from being developed. And they continue to do so because governments and investors allow them to.

Divestment campaigns have started to change that, causing $12 trillion in assets to be pulled from businesses dependent upon fossil fuels. But the movement may have picked up some significant additional momentum this week as one of the largest investment firms, BlackRock, announced that it will be making sustainability, and climate change in particular, central to its strategies. Included in its announcement is that it would immediately begin pulling out of many coal investments and complete the change before the year is out.

What BlackRock can and cant do

BlackRock's new policy was announced in an open letter from its CEO to the companies that it invests in (or might invest in). The consequences of that policy were elaborated by an accompanying letter from its management team to its investors. We'll spend some time on the details of this policy and the reasons for it below. But we'll first explain why BlackRock's decision is significant and a number of factors that can 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. Purely from a PR perspective, a company that size focusing on sustainability puts pressure on other investment firms to follow, lest they be seen as poor global citizens. But BlackRock's announcements also lay out a strong argument that focusing on sustainability is a powerful tool for avoiding financial risks. If other investors find these arguments compelling, then other firms could be forced to follow suit.

In managing the money investors have put into it, BlackRock and these other firms are bound by "fiduciary duty," which means that it has to act in the best interests of its investors. Effectively, this means the company has to make the case that changes in its investment strategy represent sound financial decision-making.

BlackRock's ability to act, however, is limited by the nature of some of the things it offers to investors. Assets are often invested in specific funds that are meant to identify the best-performing companies in specific markets, like health care or energy. Here, BlackRock can do a number of things: changing its definition of best-performing to include sustainability metrics; offering funds that focus on companies that have sustainable business models; and offering funds that invest in specific sustainable businesses, such as renewable energy.

Many of the assets BlackRock manages, however, are invested in passively managed index funds, which put their money into companies that fit a specific definition: all the companies in the S&P 500, or all stocks that fit a definition of "small cap," for example. Here, regardless of BlackRock's focus on sustainability, there's little the firm can do to change what companies it invests in.

BlackRock can, however, potentially change the companies themselves. Investors in these funds typically give the investment managers the ability to act as proxies in votes on the company's governance. These include things like approving members of the company board 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 its voting patterns can make a substantial difference.

What it plans on doing

With a better sense of what the company can do, we can turn to what it plans on doing. In the open letters, the company's management lays out its case for focusing on sustainability.

"BlackRock does not see itself as a passive observer in the low-carbon transition," CEO Larry Fink argues. "We believe we have a significant responsibility—as a provider of index funds, as a fiduciary, and as a member of society—to play a constructive role in the transition." And, just as significantly, Fink says, customers have consistently asked for it to act on climate and sustainability issues.

Fink goes on to elaborate how sustainability fits with the company's fiduciary duty. He argues that "Climate change has become a defining factor in companies long-term prospects." As a result, investors are starting to "reassess core assumptions about modern finance," which will mean that "in the near future—and sooner than most anticipate—there will be a significant reallocation of capital." Because of this impending reallocation, firms that have a focus on sustainability provide the lowest risk, and best returns for investment, Fink argues. This provides the rationale for changing investment policies as protecting the interests of its investors.

BlackRock's CEO calls for companies to use recently developed standards to report their climate- and sustainability-related risks, as well as how they plan to operate within the limits posed by the Paris Climate Agreement. He goes on to indicate that if, the companies fail to do so, BlackRock will assume they're not managing risks properly. He then drops the big threat: "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."

Sustainable alternatives

The letter from the company's Executive Committee provides the details on some of the practical changes that will be made. For funds that are actively managed, sustainable alternatives will be developed and will ultimately become the firm's central focus. 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're managing sustainability risks, and the company will develop tools to better evaluate 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 toward limiting the company's exposure to climate risks, it's focusing on coal. "Thermal cRead More – Source