A "fundamental reshaping of finance" is on the horizon

In his 2020 letter to CEOs, Larry Fink, head of asset management firm BlackRock, focused on investors' rapidly changing perspective on climate change. "[Investors] are increasingly...recognizing that climate risk is investment risk," he wrote. "They are seeking to understand both the physical risks associated with climate change as well as the ways that climate policy will impact prices, costs, and demand across the entire economy."

"These questions," Fink continued, "are driving a profound reassessment of risk and asset values." The result of this reassessment, he predicted, will have profound ripple effects across the economy: "I believe we are on the edge of a fundamental reshaping of finance."

Times are a'changing, it seems.

A "fundamental reshaping of finance" is a difficult thing to achieve. But it also seems more possible than ever, thanks to the winds of political will blowing through Washington.

Earlier this month, Treasury Secretary Janet Yellen highlighted some of the efforts that the U.S. Treasury has underway: conducting risk assessment, altering tax policy, developing climate finance tools, and taking a stronger international leadership role.

In March, the U.S. Securities and Exchange Commission (whose sole mission is to protect investors and maintain market fairness and efficiency) signaled that it will likely start requiring corporations to provide more robust disclosure on their exposure to climate change and its associated risks.

And last week, U.S. climate envoy John Kerry announced that President Biden is poised to issue an executive order requiring disclosure of climate risks.

All of this follows massive growth in the public's awareness of and concern regarding the effects of climate change, and its indictment of the government for not taking more stringent action on climate policy.

How do climate disclosures achieve a "reshaping of finance"?

In order to decide where to invest their money, investors gather any available information about the economy, the world, and the target company they want to invest in. They then cross-reference this information with their individual risk appetite. Together these two lenses help investors decide where to invest their money.

But there is one looming risk factor that is not being assessed: the threat of a changing climate. Allowed to continue in its current course, climate change will affect the operating capacity and profit potential of companies in every sector of the economy. For a long time, both businesses' contributions to and damage from climate change were ignored. But as climate science continues to develop and predict the impacts of climate change, it is increasingly apparent that businesses are not insulated from these impacts, and in fact are major contributors to them.

A mandate for climate disclosures requires companies to recognize and quantify all the ways that their operations contribute to and are impacted by climate change. Disclosures will also highlight where a company is vulnerable to the impacts of government climate policy, or whether it is under-investing in adequate climate technology.

Armed with this information, investors like BlackRock will have a much clearer picture about the profitability and expected returns of their investments, and may choose to shift their investments to companies that are proactively addressing their exposure to climate change. This shift, across the U.S. financial sector, is what Fink meant when he predicted that "in the near future...there will be a significant reallocation of capital."

How does all of this affect climate change?

This capital reallocation is crucial to addressing climate change: the funding provided by investors powers the development of new technology, enables businesses to grow and scale operations, and finances retrofits of highly-emitting factories and production lines. The 'reshaping' of the financial world will in fact cause the reshaping of the physical world.

The U.S. is playing catch-up to the European market, where requirements for climate disclosure have been developing for some time. But if the signs are correct, and climate disclosures become a mandate in the U.S., the corporate landscape could be due for some big changes.

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Afterword: The conversation about how government and financial institutions can work together on climate change is always evolving. I recently read this interview with BlackRock's former head of ESG investing, who advocates a much stronger government response.

Header image credit: Leah Millis - Reuters/Stock.Adobe.com