Climate change risk.  Longer term sustainability of companies.  The reshaping of finance. Transparency of reporting.  Connection to purpose. These were all key themes of this year’s annual letter to CEO’s from BlackRock Chairman and CEO Larry Fink. 

Larry Fink’s annual letters to CEOs of companies in which BlackRock invests are fast obtaining a well-deserved reputation as a must read.  They are usually ahead of the curve, or at the very least “on the money” regarding issues for companies to be concerned about.  

For anyone not aware, BlackRock has earned its reputation for being “on the money”.  It’s a global investment manager of eye watering proportions and reputed to be the world’s largest money manager with nearly $7 trillion of assets under management. And those are US dollars and hence worth a bit more than our humble kiwi ones.  As such BlackRock under Larry Fink are a very influential investor and when they speak, the companies they invest in tend to listen.  Or at least would be wise to.

Having said that, their pronouncements have not been without controversy.  

The last 2 year’s letters for example suggesting the importance of purpose over profits resulted in a lot of debate and even outright angst.  The key concept expressed being that continuing to adopt an ingrained short-term, myopic, shareholder-return-is-the-goal strategy will only lead to moral and eventually financial bankruptcy. Instead the astute observation was made by Fink that “Society is increasingly looking to companies, both public and private, to address pressing social and economic issues”.   In essence, a call for purpose over profit.  Or at least an appreciation that “Purpose is not the sole pursuit of profits but the animating force for achieving them”.

This message was seen by many as a direct attack on the concept of shareholder primacy and pure capitalism.  From a legal perspective it raises interesting questions regarding the role of directors.

Alternatively, others saw it as advice to business reflecting sustainability best practice and it being fantastic news for anyone concerned about the rising issues of social disruption and environmental destruction.

So what’s in the 2020 letter?     

  • Climate Change

The 2020 letter highlights that climate change has become a defining factor in companies’ long-term prospects.

It also expands on how this is likely to lead to a fundamental reshaping of finance.   Especially if investors are unable, or unwilling, to estimate the impact of climate risk over a long timeline such as the traditional 30 year mortgage – a key building block of international finance.  Or if there is no viable market for flood or fire insurance in impacted areas.

Astute investors are increasingly recognising that climate risk is investment risk. The questions arising from this are likely to drive a profound reassessment of risk and asset values.

The observation is also made by Fink that capital markets tend to pull future risk forward.  As such it is likely that capital allocations may change faster than changes of the climate itself.  Hence in the near future, and possibly sooner than most anticipate, that there will be a significant reallocation of capital.

Coordinated action on climate change towards a low-carbon world must be led by Governments and it is important that these transitions are managed in an equitable way, but companies and investors also have a meaningful role to play.

  • Improved Disclosure for Shareholders (& others)

A strong call is made that all investors, along with other key stakeholders such as regulators, insurers, and the public need a clearer picture of how companies are managing sustainability-related questions.  They need to transparently show how their strategies are sustainable.

“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.”

“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.”

The key point being made about appropriate transparency is that in the absence of robust disclosures, investors, including BlackRock, will increasingly conclude that companies are not adequately managing risk.

“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.”

  • But what do the critics say?

Unsurprisingly any such announcement also draws its share of criticism, and from both CEOs and climate activists. 

Some climate activist critics have quickly come out highlighting that while BlackRock’s actions and letter are a step in the right direction that BlackRock is not doing enough itself, especially as they remain a significant investor in coal, oil and gas.  Other CEOs and corporates have criticised BlackRock for engaging in PR more than action.

There has also been criticism of sustainability or ESG (Environmental, Social, Governance) reporting.  A recent Harvard Business Review article noting their authors’ view that “most sustainability reporting is unreliable, inconsistent, and largely covers factors that are immaterial both to the economic performance of the company and to the company’s global impact.”

Hence if Fink is correct in predicting that capital will increasingly be allocated to those companies with the most sustainable business models, then investors will need new sources of data to understand and anticipate the economic significance of sustainability strategies. 

This will be the significant communication challenge in the next few years faced by NZ companies and their directors and advisors, as it will be internationally.

  • Summary

Whether you agree wholeheartedly or gnash your teeth in outrage, the above messages from the world’s largest money manager are in my view well worth pondering. 

There are undoubtedly significant threats and uncertainties being posed to the traditional economy and financing as we have known it.  However equally as with any change, there are significant potential opportunities. 

To realize those opportunities will require companies, their directors, and their advisors including their lawyers and accountants, to be able to consider how the issues impact them and then take action to respond appropriately. 

Those who get this right potentially have a lot to gain.  Those who ignore it do so at their peril.

This article was first published in LawNews. LawNews is the weekly publication of ADLS published every Friday, and distributed to ADLS members, subscribing lawyers, parliamentarians, newspaper editors, educational institutions and other law societies in New Zealand.