BETWEEN A BLACK ROCK AND A HARD PLACE - TICK TOCK THE CLIMATE CLOCK – PART 29

"The near-term impacts of climate change add up to a planetary emergency that will include loss of life, social and geopolitical tensions and negative economic impacts," according to the World Economic Forum's Global Risks Report 2020.  

It was undoubtedly the “near-term negative economic impacts” that got the Davos crowd’s attention.  All top five of the ten most significant risks to the world economy, as ranked by this year’s Davos attendees, were environmental risks.  Extreme weather was number one, followed by climate action failure. 

No wonder.  According to The New York Times at NYT Davos:

Extreme weather events are already causing economic havoc. The California wildfires last year were estimated to have caused $25.4 billion in damage. Pacific Gas & Electric, the largest energy producer in the state, has filed for bankruptcy. Energy prices in Sweden skyrocketed during a recent heat wave. Fires in Australia have disrupted business there.

[T]he chief executive of Ikea said his company was already feeling the impact. Severe flooding in the United States temporarily closed many of its stores. [T]he chief executive of Marriott said the hotel chain was also feeling the brunt. “We have hotels in Puerto Rico that are still closed,” he said. “We’re going to see the impact of fires and storms.”

A report this week from the Bank for International Settlements, which represents central banks, said climate change could cause the next financial crisis.

And that doesn’t even take into account pandemics like Covid-19, which has also been linked to climate change.  What is the corporate world doing to mitigate the economic risks of climate change?  Not much, per the Times article above:

Despite talk of the risks, few companies and investors provided details at Davos on how they would rapidly transition away from an economy based on fossil fuels. Just a fraction of global businesses currently disclose the financial risks posed by climate change. Even fewer have set their own targets and timetables to do what the science demands: Reduce total greenhouse gas emissions by half over the next decade.

Ms. Martin, of Zurich Insurance, said the real evidence of change would come when investors started exiting carbon-heavy companies, especially those with no transition plan. “What is going to cause the change?” she added. “If capital actually does start to fly, if it does actually make choices.”

Is capital making choices and taking flight?  One mega-investor appears to be revving its engines on the tarmac.  Larry Fink, the C.E.O. of BlackRock (above), which manages an eye-popping $7 trillion, said assessing climate risk has become integral to BlackRock’s investment strategy.  In his annual letter to corporate C.E.O.s Fink said:

The evidence on climate risk is compelling investors to reassess core assumptions about modern finance….Will cities, for example, be able to afford their infrastructure needs as climate risk reshapes the market for municipal bonds? What will happen to the 30-year mortgage – a key building block of finance – if lenders can’t estimate the impact of climate risk over such a long timeline, and if there is no viable market for flood or fire insurance in impacted areas? What happens to inflation, and in turn interest rates, if the cost of food climbs from drought and flooding? How can we model economic growth if emerging markets see their productivity decline due to extreme heat and other climate impacts.

Investors are increasingly reckoning with these questions and recognizing that climate risk is investment risk. Indeed, climate change is almost invariably the top issue that clients around the world raise with BlackRock.

These questions are driving a profound reassessment of risk and asset values. And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself. In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.

Fink’s letter goes on to say that BlackRock would begin to shed investments that “present a high sustainability-related risk,” citing coal, but that he would not exit fossil fuels entirely, as oil and natural gas will continue to play a role in the energy-transition economy.  Fink also said he intends to encourage every company to rethink its carbon footprint and will press its portfolio companies to disclose plans “for operating under a scenario where the Paris Agreement’s goal of limiting global warming to less than two degrees is fully realized.”  BlackRock, he said, 

…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. 

Fink also said BlackRock plans to introduce new funds that screen out fossil fuel-oriented stocks to give capital a choice.

That all sounds pretty darn good, despite the tentativeness of words like “would begin,” “intends,” “to encourage,” “will press,” and “will be increasingly disposed to.”  It’s hard to know if Fink is hedging his commitments here or is being deferential to fellow plutocrats.  One thing we do know, BlackRock is in business to make money for itself by making money for its clients.  After all, that’s capitalism.  But is making money the main driver of BlackRock’s assessment that climate risk is investment risk?  An article in The New York Times at NYT Fink suggests it likely is:

Had Mr. Fink moved a decade ago to pull BlackRock’s funds out of companies that contribute to climate change, his clients would have been well served. In the past 10 years, through Friday, companies in the S&P 500 energy sector had gained just 2 percent in total. In the same period, the broader S&P 500 nearly tripled.

If energy stocks aren’t generating the returns its clients want, then dumping or under-weighting them is a smart portfolio strategy for BlackRock.  And since alternative energy stocks did extremely well last year, (the top five yielded average returns of 211%), it makes sense to move capital over to them.  It’s unclear what percentage of its total funds under management will be comprised of sustainability-oriented companies, or the percentage of its assets under management that will be invested in such companies, but Fink has shown us in his client letter BlackRock’s intentions (again, less than a promise) as to the numbers of proprietary environment-friendly funds:

We intend to double our offerings of ESG ETFs [environmental-social-governance electronically traded funds] over the next few years (to 150), including sustainable versions of flagship index products, so that clients have more choice for how to invest their money.

By doubling the number of environment-friendly ETFs available to clients who see climate risk as investment risk, BlackRock is giving them a choice to let their capital fly.  If BlackRock fulfills its intentions, that will be a good thing.

So much for the investor side of the equation.  But what about the corporate side?  Is there something BlackRock can do to influence the climate decisions of the companies which comprise its funds?  Will Fink make good on BlackRock’s threat to vote against management teams in portfolio companies that lack serious plans to meet the Paris Agreement goals?  Here’s where it gets interesting. 

BlackRock is the world’s largest investor in index funds, baskets of stocks that passively track and are part of a stock market index, such as the S&P500 or the NASDAQ.  Index fund managers charge very low fees, as little as 0.04% of assets under management, and aim to produce returns that hit or exceed the index benchmark.  Because of their low fees and reliable performance, index funds have become very popular.  For example, if you had invested last year in an index fund that tracks the S&P500, you would have seen a 31.5% return on your investment.  According to Bloomberg at Bloomberg:

The index fund is one of a handful of unambiguously beneficial financial innovations. Before it caught on, investors routinely paid sky-high fees to active stockpickers who often delivered subpar returns. The near-universal popularity of index funds puts them up there with Social Security, Stevie Wonder, and streaming TV.

Indexing also has been a runaway success for some fund companies. The largest asset manager in the world, BlackRock Inc., best known for its iShares brand of exchange-traded index funds, has $7 trillion under management. Index pioneer Vanguard Group Inc. has $5.6 trillion. The No. 3 indexer, State Street Corp., manages $2.9 trillion. These companies also run active funds, but together they hold about 80% of all indexed money. They’ve come to be known as the Big Three.

Their success has had a weird and unintended consequence. As millions of investors have done the most sensible thing financially, they’ve also concentrated shareholder power in the Big Three. Some 22% of the shares of the typical S&P 500 company sits in their portfolios, up from 13.5% in 2008. Their power is probably greater, given that many stockholders don’t bother to vote their shares.

Because BlackRock is such a large shareholder in these indexed companies, it is assured of a meaningful vote at their annual shareholder meetings.  Being a heavyweight also gives BlackRock the right to propose its own sustainability-friendly shareholder resolutions and to support other shareholders’ similar resolutions.  What’s been BlackRock’s track record on this?

In a word:  Abysmal.  Again, Bloomberg:

The power of the index funds is also becoming a concern of social activists. One study found that BlackRock and Vanguard voted against at least 16 climate-related shareholder proposals in which their support would have given the measures a majority of votes. The study, conducted by the nonprofit Majority Action, looked at 41 climate change-related proposals [in 2019] ranging from setting greenhouse gas emission targets to disclosing environmental lobbying activity. BlackRock and Vanguard were less likely than their fund company peers to back the resolutions, supporting them less than 15% of the time.  [See p. 17 of the study.]

While Fink says BlackRock “will be increasingly disposed to vote against management and board directors” who don’t toe the climate line, given its performance last year, it will have to do a 180° to achieve that goal this year.  Can we believe Fink?  Much as I want to, there are reasons to be skeptical.  

As the study points out, there are two principal drivers of BlackRock’s historic alignment with management:  conflict of interest and greenwashing "engagement."  The conflict of interest driver arises from the fact that BlackRock often wears two hats:  it manages the pension funds and 401(k) plans of the corporations in which it holds shares.  From the study:

BlackRock, Vanguard, and other fund managers do not make their investment stewardship decisions in a vacuum….As corporate governance experts have long noted, BlackRock, Vanguard and other fund managers face powerful and structural conflicts of interest that arise from both providing services to corporate issuers and casting proxy votes at those same corporations. Academic research has shown that the “volume of business that investment managers receive from corporate pension funds is associated with their voting more frequently in support of corporate managers on shareholder proposals, as well as on executive compensation matters.”

 

As if that weren’t disconcerting enough, the study further points out another climate conflict:

BlackRock faces its own climate-specific conflicts, which may be hindering the company’s ability or willingness to assume the mantle of climate leadership that is so urgently needed. As reported by the Institute for Energy Economics and Financial Analysis, six out of BlackRock’s 18 board members have backgrounds in the fossil fuel sector, including BlackRock’s lead independent director [pictured below].

The second driver is greenwashing “engagement.”  From the study:

BlackRock claims it fulfills its investment stewardship responsibilities through the shareholder engagement it conducts bilaterally with its portfolio companies. While BlackRock has long promoted this bilateral activity as a superior alternative to supporting shareholder resolutions, there is no evidence that their engagements have actually led to widespread positive behavioral change among companies on climate change. As noted above, many major energy companies have yet to make the commitments and plans necessary to meet the challenges posed by climate change. Moreover, these private engagements are notorious for their lack of transparency, leaving BlackRock’s clients and the broader investor community with no means of assessing their efficacy. BlackRock’s disclosures contain no information about what bright lines it draws with companies on climate change or other issues, and do not indicate how company responses to engagements would lead BlackRock to support or reject company nominees for a corporation’s board. Unfortunately, all that is clear is that BlackRock systematically fails to back up its “engagement” efforts with action.

I think there may be an additional, more mundane reason for BlackRock's failure to be a proactive shareholder:  low management fees.  At 0.04%, a fund manager would have to be pretty darn motivated by non-financial concerns to get in the weeds and fight for climate issues with management.  As an article in Axios at Axios  notes:

At the corporate level, it makes little economic sense for a company to unilaterally constrain its options while its competitors retain freedom of action.  The option to pollute is worth money. 

The only way to eradicate that competitive disadvantage is to ensure that all companies [emphasis added] have to play by the same rules.  Those rules can be drafted by governments or by shareholders. 

Certainly, in theory, climate-friendly rules can be drafted by shareholders, but only if there are shareholders and only if they're so motivated.  But the reality is that climate change is a global problem that doesn’t affect just capitalist countries, where shareholders own the means of production.  Climate change affects all countries, including socialist countries (think China!), where the state, not shareholders, owns the majority of the means of production.  

So to think that shareholders in capitalist countries can carry this global burden of ensuring that all companies world-wide play by the same climate-friendly rules seems to me to be fatally unrealistic.  Moreover, it's hard to imagine a governmental rule-making strategy succeeding within a capitalist economy if business runs government and not vice versa.  In such economies, capitalism is the problem and regulating it is the solution.  In socialist economies, the state is the problem, and I don’t have a solution for that, other than to hope that the human drive toward self-preservation will dictate reasonable state action.

This commentary in project-syndicate.org by economist Yanis Varoufakis (pictured above), written just after Davos and around the time of Fink’s annual letter, brings us full circle.  It’s entitled Greta Thunberg, Donald Trump, and the Future of Capitalism.  Varoufakis is the leftist Greek anti-austerity former Finance Minister who pissed off the IMF and the EU during the Greek debt crisis.  His commentary may be deliberately provocative, but he makes some cogent points:

Some lament the Trump administration’s animosity toward young people and scientists who speak common sense about a massive threat that we should confront through global cooperation. But Trump and his cabal appear to understand something that their liberal detractors do not: One cannot acknowledge the perils of climate change, commit to doing whatever it takes to reverse it, and continue to think of capitalism as a natural system that can be tweaked to deliver shared, green prosperity.

Trump gets it: climate change is capitalism’s Waterloo. There is simply no feasible path toward the re-stabilization of the climate that is consistent with the maintenance of capitalism’s main pillars. The system we live in, unlike the one implied by college economics textbooks, turns on a pathological dynamic recycling mechanism: Oligopolies extract exhaustible value from humans and nature at breakneck speed, financed by debt-turbocharged financialization, which in turn fuels the extractive oligopolies.

This “technostructure,” as John Kenneth Galbraith christened this mechanism in his 1967 book The New Industrial State, will never willingly accept the limits on physical growth and extraction necessary for containing climate change, because it could not survive. With the political class utterly dependent on it for campaign financing, any cap, quota, or emissions trading scheme imposed by the government will prove cosmetic and, ultimately, impotent. In the same way that economics students study market failures as exceptions to an otherwise well-functioning market system, centrist reformers undergo the Sisyphean task of imagining a reformed, green capitalism.

Uncouth and disagreeable, Trumpism is nonetheless an honest manifestation of the historic moment when late capitalism pushed humanity past the point of no return. Trump urges us to carry on, while Mnuchin suggests that Thunberg numb her soul with the opium of mainstream economics. The only alternative to their policy of accelerated climate change, to the oil and finance curses that drive capitalism, is the wholesale disintegration of today’s technostructure. Do we have the stomach for it?

That remains to be seen.

Keep it real!

Marilyn