As the toll of climate risk events climbs, the finance sector is at a crossroads of conventional wisdom and best practices. This year, in the weeks following devastating Australian fires and unprecedented flooding in Indonesia, climate-related risks dominate the World Economic Forum’s Global Risks Report 2020 top five long-term risks. The experts who inform the annual WEF survey likewise highlight climate-related risks are among the most important short-term risks. In short, climate risks are here now. And they are gravely serious for the economy as well as the planet: A new paper from the Bank for International Settlements, the central banks for central banks, warns, “Climate change could… lead to ‘green swan’ events and be the cause of the next systemic financial crisis.”
The financial sector, in particular, is sending strong signals that it has reached a tipping point in addressing climate risks. Earlier this month Larry Fink, CEO of BlackRock, called for a “fundamental reshaping of finance” to address the various risks climate change poses to investments. The fact that climate risk is investment risk has been stated for years by leading voices in the finance and policy communities, including by Mark Carney, former Governor of the Bank of England and Chair of the G7’s Financial Stability Board, the Paulson Institute’s “Risky Business” reports, and more recently by the Global Commission on Adaptation. To have Blackrock – which as the world’s largest asset manager with almost $7 trillion of assets under management – explicitly recognize climate risk is a watershed event.
Importantly, Fink announced that BlackRock will screen all investments – both new and in the portfolio – for sustainability issues, including climate risk. Beyond having recognized climate risk, Blackrock will now actively assess and manage such risks. This direct, practical action will undoubtedly have a ripple effect on listed equities, virtually all of which BlackRock owns and which will necessarily respond to its calls for serious climate-related risk management and disclosure. Moreover, BlackRock has the potential to catalyze a ‘domino effect’ as other asset managers, either emboldened by BlackRock or fearful of falling behind, will most likely follow suit.
As investors recognize the potential value at risk from climate change, threatening to upend the risk-return profile of portfolios, greater awareness among asset owners may drive a recalibration of priorities. Growing pressures from capital owners and an expanding universe of investable opportunities will enable new approaches that better align capital allocation with climate goals.
This goal is increasingly synonymous with applying a climate change lens to traditional efforts to maximize risk-adjusted returns: As climate-vulnerable assets and business models face disruption from low-cost alternatives and new business models, smart capital is shifting to the climate-smart, sustainable alternatives. As the potential for carbon assets to decline sharply in value, the prospect of stranded assets across the fossil-fuel economy is growing more plausible. With record-breaking green bond issuance and flow of capital into ESG funds, low-carbon, climate-resilient, and sustainable investments are no longer the investment opportunities of tomorrow; they are increasingly the investments of today.
Though to many, it may have seemed like a bolt from the blue, Blackrock’s announcement did not come in a vacuum; the asset management community as a whole is rapidly realigning towards climate-conscious practices. In Larry Fink’s CEO letter, perhaps less appreciated than the new commitments regarding sustainability risk was BlackRock’s commitment to join the Climate Action 100+. The Climate Action 100+ is a coalition of more than 370 institutional investors that, with the addition of BlackRock, now represents $41 trillion in assets under management (AUM). This coalition, whose mission is “to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change”, reflects a broader trend among institutional asset managers towards low-carbon, climate-smart investment strategies.
Even more aggressive than the Climate Action 100+ is the Net-Zero Asset Owner Alliance, a UN-convened international group of a dozen institutional investors with $4 trillion AUM “delivering on a bold commitment to transition their investment portfolios to net-zero GHG emissions by 2050”. Other initiatives of large and influential asset owners and managers include the Ceres Investor Network, a group of investors with $29 trillion AUM that “works with investors specifically to better manage carbon, water, and supply chain risks, and ramp up global investments in clean energy and sustainable food and water systems”, and IIGCC, a group of more than 200 European institutional investors representing €30 trillion AUM “better integrate climate risks and opportunities into their investment processes and decision-making”. These groups are looking not only to change investor behavior, but also to enlist policymakers, stock exchanges, and listed companies to evolve practices around capital allocation, risk management, and disclosure. Blackrock’s new emphasis on pushing companies to report according to SASB and TCFD standards will reinforce these frameworks as de facto standards.
Beyond asset management, even some of the largest Wall Street banks and global insurance companies are now vocally and substantially changing their investment practices. Goldman Sachs’ CEO, David Solomon, in a Financial Times op-ed in December, announced $750 billion of investment in the climate transition over the next decade and foreswore investment in thermal coal and Arctic oil exploration, becoming the first major American bank to do so. Beyond these commitments, BNP Paribas-owned Bank of the West doesn’t invest in fracking, shale, or tar sands. Norway’s $US1 trillion sovereign wealth fund will divest from a slew of coal companies and oil explorers and producers, following a decision on tighter investment rules by Norway Parliament. Japan’s Government Pension Investment Fund, managing 159 trillion yen ($1.5 trillion), is soliciting green-bond indexes from private-sector index companies. And the informal club of financial institutions having restricted investment in coal projects, which BlackRock and Goldman Sachs just joined, is now 120 members strong.
Perhaps most indicative of all the signs of investors’ turn towards the climate-smart assets of the future is the change in the economics of fossil fuel investing. Quite simply, many fossil fuel investments are not delivering returns. The energy sector in the S&P 500 – primarily constituted of oil & gas majors – returned only 6% over the last decade, the worst-performing sector by far, while the entire U.S. stock market returned nearly 200%. The 43 largest U.S. oil companies lost $90 billion between 2014 and 2018; shale gas producers in the U.S. are predominantly unprofitable, and blue-chip companies like ExxonMobil are experiencing credit downgrades. Coal company assets have declined in value precipitously – down 73% in 12 months in the U.S. – as demand has cratered in OECD markets. India and China have recently canceled dozens of gigawatts of planned coal power plants. And a new RMI study found that grid-scale renewable power in the U.S. is now cheaper than building new gas power plants, and will become cheaper than operating existing natural gas generation by the mid-2030s, suggesting that these power plants too are at risk of becoming stranded assets. Already, low oil and gas prices are leading to massive multi-billion-dollar write-downs in the value of proven reserves by large oil & gas majors such as Chevron and Repsol. AXA S.A., a French multinational insurance company, has decided to divest from companies most exposed to coal-related activities.
Mainstream investors are increasingly contemplating strategies to actively shift from climate-exposed assets, currently widespread throughout the economy and capital markets – from portfolio holdings, project pipelines, lending operations, and insurance underwriting – and pursue investor engagement with portfolio companies to demand more proactive climate risk management and corporate strategies oriented towards a climate-smart future. The days of climate-blind investing are rapidly coming to an end. The era of mainstream climate-smart investing is arriving.