BlackRock’s stark warning on business risk

Climate change risk. Longer-term sustainability of companies. The reshaping of finance. Transparency of reporting. Connection to purpose.

Craig Fisher

These were all key themes of this year’s annual letter to CEOs 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” about issues that should concern companies.

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 currency. As such, BlackRock under Fink is a very influential investor; when it speaks, the companies it invests in tend to listen. Or at least they would be wise to listen.

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

The past two years’ letters, for example, suggesting the importance of purpose over profits, resulted in a lot of debate and even outright angst.

The key concept was that continuing to adopt an ingrained, short-term, myopic, shareholder-return-is- the-goal strategy would lead only to moral, and eventually financial, bankruptcy. Instead, Fink astutely observed that “society is increasingly looking to companies, both public and private, to address pressing social and economic issues”.

In essence, it was 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”.

Many saw this message as a direct attack on the concept of shareholder primacy and pure capitalism. From a legal perspective it raises interesting questions about the role of directors.

Others saw it as advice to business, reflecting sustainability best practice and as 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 letter highlights climate change as 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.

Fink observes that capital markets tend to pull future risk forward. As such, capital allocations may change faster than climate change itself. Hence, and possibly sooner than most anticipate, there will be a significant reallocation of capital.

Coordinated action on climate change towards a low-carbon world must be led by governments. It is important for these transitions to be managed equitably but companies and investors also have a meaningful role to play.

Improved disclosure

Fink makes a strong call for all investors, along with other key stakeholders such as regulators, insurers, and the public, to have 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,” Fink says. “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 scepticism 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 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.”

The critics

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

Some climate-activist critics are saying while BlackRock’s actions and letter are a step in the right direction, it is not doing enough itself, especially as it remains a significant investor in coal, oil and gas. Other CEOs and corporates have criticised BlackRock for engaging in PR rather than action.

There has also been criticism of sustainability or ESG (Environmental, Social, Governance) reporting. A recent Harvard Business Review article noted “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”.

So, if Fink is correct in predicting capital will increasingly be allocated to 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 for companies and their directors and advisors.

Threats and uncertainty

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

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

Realising these will require companies, their directors, and their advisors – including their lawyers and accountants – to consider how the issues impact them and respond appropriately.

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

Craig Fisher FCA is a chartered accountant and a consultant at RSM. He is an ADLS council member

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