BlackRock Starts to Walk the Talk

BlackRock has made a meaningful and public move on natural capital engagement. The investment management company is asking companies ‘to have clear action plans to manage climate and natural capital risks’.[i] Although BlackRock has become increasing vocal about climate change in recent years, natural capital impacts are now on its engagement menu. We applaud them for this move.

A natural capital spotlight

BlackRock defines natural capital as ‘the supply of the world’s natural resources from which economic value and benefits can be derived’. And it provides three main reasons why it is asking corporates to have a clear action plan to manage natural capital risks.

• The way in which a company manages material environmental, social and governance factors can be a signal of operational excellence and management quality.
• For those business models which have material dependencies or impacts on natural capital, the management of these factors can be a defining feature in their ability to generate long-term, sustainable value for shareholders.
• Companies that fall short may face regulatory, reputational or operational risks.

We support such views and have argued as such in our research. For example, in Growing for Profit Planet Tracker analysed 37 listed equity funds in the food and agriculture sectors. We identified initiatives, responsible investment guidelines and research related to the food and agriculture sectors designed explicitly, or in part, for asset managers firstly to identify and measure company level natural capital risks and secondly to align their portfolios with market-based sustainability criteria and, in certain cases, regulations. Of the 37 AgriFunds assessed, only 8% reference one or more of the natural capital risks which have a direct material impact on food and agriculture production.

Furthermore, only a single fund communicates a commitment to one or more of the sustainability initiatives selected in this report in their 2018/19 annual reports and related securities’ filings. Why AgriFunds do not review sustainability practices when they are clearly reliant on natural capital is perplexing.

Natural capital as an investment issue

Planet Tracker concurs with the BlackRock view that ‘natural capital and climate are interconnected’ but cautions against viewing natural capital as only a climate issue. Natural capital is also fundamental to food provision and should be viewed in this context as well. In a similar fashion, we agree that ‘all companies rely on natural capital and/or impact it in some way’. Again, the same rule should be applied to sovereigns and their financing. In The Sovereign Transition to Sustainability we explored the dependence of sovereign debt and nature. This paper concluded that the value of sovereign bonds relies in part on the management of natural capital.

Argentina and Brazil were identified as the G20 countries most dependent on natural capital for their exports. However, this reliance is still largely ignored or mispriced. We encourage financial institutions to recognise this linkage.

The recognition by BlackRock that it is ‘particularly interested in understanding companies’ impacts on the communities in which they operate, locally or through their supply chains’ is laudable. This can often go unrecognised by the financial markets. Our recent research paper Tackling Overfishing: Preventing Yellowfin Tuna Collapse in the Indian Ocean deliberately highlighted the social consequences of a collapse in fish stocks, underlining that developing coastal nations do not have access to foreign catch quotas or significant deep-water fleets, and so a collapse of yellowfin species damages their trade balances. Developing coastal states are also more dependent on yellowfin tuna as a total percentage of exports. Collapse in yellowfin tuna could lower current trade balances of current net exporters – such as the Seychelles and Maldives – lowering national fiscal health. The voices of smaller island developing states (SIDS) can get lost in the discussions as can happen in the climate change debates as well.

Planet Tracker has also found evidence to support the view of BlackRock that ‘a company that fails to effectively oversee risks related to the use of natural resources may face negative consequences arising from regulatory, reputational or operational risks, among others’. Operational risks may be buried in a hidden part of the supply chain, but the risks are there nonetheless. Our research into textiles which culminated in the report Will Fashion Dye Another Day? exposed this in the textile supply chain. The report focused on the financial risks arising from the extensive use and misuse of water in the wet processing stage of clothing production, with much of the global production effort situated in areas where water stress and the associated risk is already high. This comprehensive analysis identified 230 wet processing companies with a combined market cap of USD 586 billion to investors. 51 companies worth USD 29 billion rank ‘extremely high’ or ‘high’ on WRI’s water risk scale, indicating the magnitude of the risks embedded in the fashion brands’ supply chains.

But when considering a natural capital strategy, sovereigns and corporates should also seek the opportunities. There is often an asymmetrical focus on the risk side of the equation. In Bonds for Ponds we highlighted how two seafood companies, the first to raise green bonds in this sector, were able to secure upfront capital for innovative feeds and to transition to deforestation-free soy for aquafeed in their aquaculture businesses. There has been a similar move in the textile sector whereby sustainability-linked bonds are being used to competitively finance sustainability targets. See Ethical Debt is the New Bespoke Fashion.

The expectations

BlackRock has stipulated a number of expectations from the companies in which it is a shareholder. These are outlined below:

• Disclose how material natural capital risks and opportunities might affect their operations, long-term strategy, capital expenditures and risk management, as well as the communities in which they operate.
• Encourage companies to explain how relevant risks are identified, assessed, managed and mitigated, and how opportunities are harnessed.
• Encourage reporting aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and the metrics identified by the Sustainability Accounting Standards Board (SASB).
• Explain the board’s role in overseeing management’s approach to natural capital dependencies and to incorporating sustainable practices into the business – e.g. understanding how the board and management keep abreast of natural capital trends likely to impact the business.
• Encourage companies that materially depend on natural capital to contribute to, or help establish, programmes that support the conservation of those resources – e.g. efforts to preserve biodiversity and ecosystem health, reforest land, conserve water, minimize waste and pollution, and promote recycling, etc.
• Take all possible steps to see these efforts carried through their first and second tier supply chains.
• Take on the challenge of producing more with fewer inputs.
• Actively participate in industry initiatives to help contribute to sector-level supply chain improvements – e.g. storage and logistics and traceability programmes.

All of these expectations lead to a list of 12 disclosure requests which range from identifying and disclosing natural capital related risks and the managements and board’s specific roles in mitigating and overseeing natural capital risks to supply chain due diligence processes and participation in industry collaboration aligned with addressing pervasive issues.

Finally, BlackRock declares three natural capital focus areas: biodiversity preservation, deforestation risk management and freshwater & ocean protection.

Planet Tracker has recently written about the struggle of investors in finding and investing in suitable deforestation investments. In Exchange Traded Deforestation we noted the boom in exchange traded funds (ETFs), as well as the resurfacing of synthetic ETFs and the emergence of a semi-transparent ETFs version – but their structures hide entrenched deforestation risk from investors. In the more recent Online Retail Investors: Can’t See the Woods for the Trees, our findings reveal that, despite the growing demand for sustainable or environmental, social and governance (ESG) investments, there are little to no provisions in place to help investors identify these investments.

For example, none of the websites we surveyed (including BlackRock’s) allowed the potential investor to exclude deforestation risk. We welcome a focus on deforestation by BlackRock.

The emphasis by the investment manager on freshwater and ocean protection is well justified. Their particular focus on plastic pollution is extremely timely and very welcome. Planet Tracker believes we are on a trajectory whereby the single-use plastic pollution is set to worsen unless drastic action is taken. In Stormy Outlook we discuss the planned capacity increases and whether these facilities are destined for stranding in the near future. BlackRock warns that ‘companies that fall short may face regulatory, reputational or operational risks’. We have identified the plastics industry, especially single-use plastics, as already having embarked along this road. The regulators are closing in. See California Leapfrogs EU with First State-Wide Recycled Plastic Bottle Mandate in the U.S. On the other side of the Atlantic the same pressures are evident. See EU Recovery Plan’s “Bottle Deposit Law” Plastic Waste Levy Begins in January 2021, but Recycling Infrastructure Insufficient.

Where now?

BlackRock’s investment stewardship paper ‘Our Approach to Engagement on Natural Capital’ is full of sound advice for corporates – and we would add sovereigns as well. It recognises risks but opportunities as well. It provides coverage on a range of natural capital issues and provides convincing arguments as to why natural capital should be part of the boardroom and cabinet agenda. BlackRock’s list of expectations of executives provides a comprehensive starting point.

Significant questions remain, however, not least whether or not BlackRock will publish policies on issues such as deforestation to strengthen its own investment practices as well as setting out its stewardship expectations of others.

BlackRock’s voting record has been weak in the past – if its voting actions match this clear statement of intent (and if companies respond to this pressure) then its impact could be significant.

Beyond the stewardship debate, BlackRock also has an opportunity to offer investors robust and transparent sustainable investment vehicles that align capital allocation with investors’ views.

The words are very encouraging. The forthcoming 2021 AGM season will allow BlackRock to put its votes where its money is.

[i] https://www.blackrock.com/corporate/literature/publication/blk-commentary-engagement-on-natural-capital.pdf