Sustainability in the Spotlight: Is your company ready?

A Fundamental Reshaping of Finance

It’s being called a “fundamental reshaping of finance”. Climate risk is forcing investors and money managers to rethink investments in a world of unprecedented biophysical disruption to the planet. This warning does not come from climate activists like David Suzuki, James Hansen, or Bill McKibben, but from the largest asset manager in the world: BlackRock.

Each year, Larry Fink the Chairman and Chief Executive Officer of BlackRock, pens an annual letter to CEOs. The letter is influential as is serves as a template for how the asset manager will approach shareholder engagement including voting on shareholder resolutions and for board directors. BlackRock’s colossal US$6.84 trillion [1] of assets under management is not to be ignored. Chances are, if you work at a publicly traded company, BlackRock owns a stake. When Larry speaks, CEOs take notice.

This year, the annual letter was focused entirely on sustainability issues. This is fascinating to consider given all the potential risks facing investors. The letter was penned early in the year, before the COVID-19 crisis had become a full-fledged global pandemic. Still, there were many issues facing global investors at that time that were highly significant: political dysfunction in the UK, the rise of socialism in the US primaries, unrest in the streets of Hong Kong, a growing corporate debt binge, and an 11-year bull market that was starting to look wobbly. But it was the issue of corporate sustainability that BlackRock chose to highlight above all else.

So why exactly is sustainability so important? What does this mean for managers of publicly traded companies? What does my company need to do with respect to sustainability? This newsletter sets out to answer each of these questions.

Sustainability in the Spotlight

To understand why BlackRock has pushed sustainability to the top of the agenda for CEO’s in 2020, it is important to highlight a few key messages in the letter.

The first key message relates to the notion that climate risk is investment risk. While climate risk is not the only sustainability issue, in recent years, it has been the primary focus. This is largely a result of the significant projected climate change impacts on biodiversity and ecosystems [2] as well as the potential for financial losses resulting from expected government policy that will accelerate the transition to a low-carbon economy [3]. BlackRock notes that as a fiduciary, they have a responsibility to ensure that clients can navigate this transition. Confronting climate change is not an option. Every government, company, and shareholder must take notice.

Second, BlackRock notes the inadequacy of disclosure on how companies are managing sustainability-related issues. This includes data related to climate change, but also includes issues such as workforce diversity, supply-chain sustainability, and data privacy. This call for “stakeholder capitalism” serves to disrupt to concept of shareholder primacy and echoes the declarations of the Business Roundtable that recently called for a redefinition of the purpose of the corporation [4]. To achieve more standardization on how companies should report on sustainability-related issues, BlackRock calls for the widespread adoption of: 1) the Sustainability Accounting Standards Board (SASB) standards for reporting sustainability; and 2) the Task Force on Climate-related Financial Disclosures (TCFD) for evaluating and reporting climate-related governance and risks issues. Importantly, the TCFD disclosure should outline the company’s plan for operating in a world were global warming is limited to no more than two degrees as stated in the Paris Agreement [5].

The last key message highlights BlackRock’s conviction that long-term profitability is related to accountability and transparency. BlackRock warns that a significant reallocation of capital is coming as a result of climate change policy and investor pressure. Companies have a responsibility to provide investors with the information they need to inform these investment decisions. Information disclosure will also be important for a company’s ability to attract capital. As the low-carbon transition takes hold, BlackRock expects that sustainability- and climate-integrated investments will provide better risk-adjusted returns for investors.

Managers Need to Take Notice

The measures that BlackRock discusses are not optional. Sustainability will be placed at the center of their investment approach. This includes integration into portfolio construction and risk management, new investment projects that avoid investing in fossil fuels, and shareholder engagement activities with a commitment to sustainability and transparency. Additionally, and most significantly, BlackRock will divest of investments that are deemed to present a high sustainability-related risk.

If a company fails to provide a robust disclosure on sustainability-related risk, BlackRock will assume that the risk is not being adequately managed. To compel a company to provide adequate risk disclosure, BlackRock will vote against management and board directors that are not making progress on sustainability-related disclosures. In short, sustainability disclosure is no-longer voluntary so long as BlackRock is holding a stake in your company.

While Larry Fink addresses his letter to CEO’s, let’s face it: CEOs will not be responsible for implementing the required sustainability reporting and disclosure programs. CEOs will set organizational priorities and mobilize forces, but the heavy lifting will fall to you: the sustainability manager. If you’re a manager and this is not on the radar of your CEO, it probably should be. He or she will thank you. Maybe not initially – sustainability reporting requires time and resources. But when your competitor across the street fails to get shareholder support for its CEO compensation package because minimum disclosure requirements were not met, you can remind your CEO that her paycheck was approved (at least in part) because of your foresight.

Get Started on Sustainability Disclosure

While sustainability disclosure is no-longer optional, companies are unlikely to face divestment or dissenting shareholders immediately. There will be time for companies to fall in line with these new sustainability reporting expectations. BlackRock acknowledges that the energy transition will take decades. While the disclosure transition will not be quite as long, it is likely that companies will have 2-3 years to move towards full compliance with SASB and TCFD disclosure standards.

Companies should start now and use this time to work out the kinks before full compliance with sustainability disclosure standards is required. This is an iterative process. Starting now with an imperfect disclosure is better than waiting until the internal practices and procedures are 100% baked before taking the plunge.

So, what do sustainability managers need to start doing in 2020? We suggest the following:

Ensure your organization has the proper risk management and governance process in place. Sustainability-related risk is not unlike the other diverse risks your business faces. Seek to integrate sustainability into your company’s existing risk management framework.

Get familiar with SASB and TCFD disclosure standards. Make sure you understand the questions that are applicable to your organization. It is good to have the end in mind from the outset.

If you are using other sustainability standards in your corporate disclosure, now is the time to think about migration to SASB and TCFD. Historically, lack of standardization in sustainability disclosure has been a huge issue and it now seems as though there is (finally) coalescence around two frameworks. Use this insight to your advantage.

Sustainability is about more than just disclosure. Going through the SASB materiality assessment and TCFD scenario analysis could reveal significant gaps in risk management process or business decision-making. Your organization needs to make investments decisions that are resilient to a future with increasing sustainability pressure and more stringent environmental regulations.

Robust disclosure requires good data. Have the right tools in place to measure and track performance on key sustainability metrics. This could include:

• GHG emissions performance
• Water and land use practices
• Pollutant release tracking and monitoring

Practices related to human rights, worker safety, diversity and inclusion, as well as partnerships with local communities

Disclosure is only the first part of the sustainability equation; performance is the second. As BlackRock has already signaled its not just about sustainability-related disclosures but also the underlying business practices. Once investors are satisfied with corporate disclosures, their attention will quickly turn to sustainability performance metrics. Think about how to improve sustainability performance now, so you can lap the competition in the coming years.

References
[1] https://www.blackrock.com/sg/en/introduction-to-blackrock
[2] https://www.ipcc.ch/sr15/
[3] https://www.unpri.org/inevitable-policy-response/what-is-the-inevitable-policy-response/4787.article
[4] https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans
[5] https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement