When it comes to the financial markets, I am a perennial optimist. Investing not only makes us richer in the long run, it makes the world healthier, happier, and better in almost every dimension.
My optimism extends even to the ability of financial markets to solve what economists call coordination problems, an excellent and timely example of which is global climate change: everyone would be better off on average if we all took steps to reduce carbon emissions. But as an individual, I am better off if I don’t do anything about my carbon footprint, because using fossil fuels is convenient to me, and my using them has no noticeable impact on the environment that can possible effect my life. Because everyone on earth faces this same logic, in equilibrium we all end up using more fossil fuels than what we would agree would be ideal from the perspective of the human race as a whole, or so the thinking goes. This is supposedly a problem that private actors cannot solve on their own, but that only governments can fix.
Not so, say I! For the true power of the financial markets is to align the interests of the collective and the individual. If it is true that climate change will cause great economic damage if it continues on its current course, then there is a great deal of money to be saved by preventing it from continuing on its continuing course. Though some actors in the economy (namely the traditional energy sector) may benefit from ignoring the dangers of climate change, their profits may be outweighed by the losses in other industries (say, insurers and real estate developers with coastal properties). An investor with a globally diversified portfolio, with enough capital to influence the corporate governance of companies around the world, would then have an incentive to push the markets in a greener direction, even if they were motivated purely by the desire to earn the greatest possible return.
But who could such an investor be? Who could have the vast sums of capital and the strength of will required to take on such a Herculean task of solving one of the greatest challenges facing the world?
BlackRock. With over $5 trillion in assets under management, BlackRock is the single largest investor in the world, and with its recently published engagement policies for 2017-2018, is now possibly the greatest force for environmentalism on earth as well.
In the brief post, BlackRock outlines their goals in engaging with the directors and executives of the companies they are invested in (which, by the way, is basically every publicly traded company in the world). Among them is seeing that corporate boards address issues related to climate risk. Rather than repeat the empty platitudes you might expect in a briefing from a multinational financial firm, however, BlackRock has decided to bare it very big teeth: they have stated that they will vote out the boards of companies they see as ignoring climate risk:
For directors of companies in sectors that are significantly exposed to climate risk, BlackRock expects the whole board to have demonstrable fluency in how climate risk affects the business and management’s approach to adapting and mitigating the risk. We have the same expectation of boards wherever a company faces a material, business-specific risk. We would assess this both through corporate disclosures and direct engagement with independent board members, if necessary. Where we have concerns that the board is not dealing with a material risk appropriately, as with any other governance issue, we may signal that concern through our vote, most likely by voting against the re-election of certain directors we deem most responsible for board process and risk oversight.
Though this may seem understated, it is a surprisingly and refreshingly bold announcement. Economists and financial journalists have long bemoaned the fact that institutional investors are often too cozy with the managements of the companies they hold, often giving corporate boards the stamp of approval at the expense of their own shareholders. BlackRock’s decision to ruffle some feathers on such a divisive issue stands in sharp contrast to the usual corporate passiveness.
This is not BlackRock’s first foray into environmental corporate activism. Last year they were one of 32 members to join the Financial Stability Board Task Force on Climate-related Financial Disclosures, an industry group spearheaded by Michael Bloomberg to encourage corporations to voluntarily disclose how their activities relate to climate change in their financial statements. Blackrock also recently published a white paper, Adapting Portfolios to Climate Change, that details how the physical, technological, social, and regulatory implications of climate change may impact investors’ portfolios. The paper is a fascinating exposition on the topic from the often unconsidered perspective of an institutional investor. One of the details in it that struck me is how concentrated the matter of carbon emissions is: according to BlackRock a mere 80 companies account for more than half of all the emissions of publicly listed corporations in the world (in quant-finance-speak we would say that carbon emissions follow a power law distribution). BlackRock notes, “As a large asset manager, we prefer dialogue over divestment. The biggest polluters have the greatest capacity to move the dial if they modify their behavior… Engagement can help nudge some in the right direction.”
As we see above, “engagement” here means “fire, if necessary.” It would seem that BlackRock has drawn up a hit list of climate change’s worst offenders, and they will be going after them in turn. Before the governments of the world really begin to take serious steps to curb carbon carbon emissions, profit-maximizing financiers may have already done the job for them. I say this is good news for investors, and potentially good news for the planet.