Climate Shockwave: Larry Fink's Call for Capital Reallocation and the Future of Finance
Did you feel that? That shockwave was Blackrock CEO, Larry Fink, stating the obvious but something often only whispered on Wall Street; “the evidence on climate risk is compelling investors to reassess core assumptions about modern finance…in the near future - and sooner than most anticipate - there will be a significant reallocation of capital.” Say what?
If you aren’t familiar with Larry Fink and Blackrock, let me provide a quick background. Blackrock is one of the largest, if not the largest (depending on who you ask) asset management firms in the world. As of the end of the third quarter of 2019, they managed just shy of seven trillion dollars. You might recognize many of the iShares ETFs, which offer investors various ways to tap into the financial markets. Larry Fink founded Blackrock and seven partners in 1988 and grew it into the financial behemoth it is today. If you follow Wall Street, you know it’s not a place where one would typically want to go against the grain because making a loud statement and being wrong can lead to severe professorial punishment. Thus, there tends to be a don’t rock the boat mentality. Confidence must be high to diverge from the suited masses, making Fink’s recent comments even more surprising and praiseworthy, and I couldn’t be happier.
Mr. Fink’s comments came in the form of a letter to CEOs on January 13th, 2020, and were distributed far and wide in the buttoned-up world of finance. He recognized recent climate change protests saying:
“Climate change has become a defining factor in companies’ 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.”
I’m especially intrigued with his statement that markets have been slow to reflect climate risk, as finance types so often tout the market’s immense pricing efficiency. Fink goes on to reveal how Blackrock itself will act, noting it will put “sustainability at the center of our investment approach.” Wow! The CEO of the largest asset management firm in the world just said his company would build its investment strategies around climate change…this is precisely what I’ve been waiting to hear.
Climate change has become a polarizing topic. It’s not the existence of climate change that fuels debates, but what to do about it (although there are still some climate change deniers). I have faith in capitalism to solve our most significant challenges, and while I believe it’s the best mechanism, it may not be the fastest to begin addressing our biggest problems. However, when industry titans like Mr. Fink buck the trend and have the courage not only to adapt his own firms’ actions but call on business leaders around the world, the timeline can, and will, speed up. In his letter, Mr. Fink issues a warning to corporate and government leaders alike, exclaiming, “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.” In short, Mr. Fink is telling leaders that if they ignore the public’s demand for action on climate change, they will be punished. This is exactly what needs to happen to ensure a safe and secure future and, in my opinion, quickly and without violence and government upheaval.
How does this shockwave translate into action? While these comments are welcome and, in my opinion, needed, they alone will not have an impact. I believe Mr. Fink’s letter represents an acknowledgment by the business community of climate change challenges and an urgency to act. It gives permission for business leaders, asset managers, and others to not only discuss climate change, but to question executives, critique sustainability plans, and factor the “risk” Mr. Fisk discussed into financial models and stock valuation estimates. Perhaps more companies will start linking sustainability goals to CEO pay, and investors will ante up and pay a premium for companies with a focus on sustainability. Assets will flow into funds that consider the environmental impact of various businesses. It will be amazing how quickly change will occur when companies realize the time has passed to damage the environment while investors look the other way so long as their investment accounts are growing. I imagine we’ll see innovations in the coming years that we can’t begin to imagine today as companies pump more capital and resources into reducing their carbon footprint to satisfy investor demands for change.
Competition is the foundation of capitalism, and we are entering a world where consumers will reward sustainability and punish negligence. This will accelerate competition for companies to become “environmental leaders” and “stewards of sustainability.” Not to be outdone (and out-earned), competitors will take action to ensure they get a piece of the pie…delicious. And that is the genius of capitalism.
