Resources

• Larry Fink’s 2020 CEO Letter, outlines the BlackRock CEO’s view that economic risks posed by climate change are driving a “fundamental reshaping of finance.” As the largest asset management firm in the world, BlackRock’s client letter sent a market signal when it advised that sustainability will be the firm’s “new standard for investing.”
• The World Bank report entitled States and Trends of Carbon Pricing provides a primer on carbon pricing and carbon markets around the world.

Guests

Host: Mike Toffel, Senator John Heinz Professor of Environmental Management and faculty chair of the Business and Environment Initiative.

Moderator: George Serafeim, Charles M. Williams Professor of Business Administration and faculty lead of the HBS Impact Weighted Accounts Project

Guest: Ron O’Hanley (MBA 1986), Chairman and CEO of State Street Corporation

Transcript

Ronald O'Hanley:
... climate is extremely important to understanding the long term value prospects of individual companies. That's what this whole impetus is around. It's not about saying we're going to preach to you about what you should be doing, whether it relates to women on boards, or climate, this is not about values. We may share those values, but it's about value, and how you're creating value, how you're ensuring that the companies in which you're investing are creating value. And that's the whole focus of this.

Mike Toffel:
This is Climate Rising, a podcast from Harvard Business School. And I'm your host Mike Toffel, a professor here at HBS and faculty chair of the school's Business & Environment Initiative, a hub for environmentally focused research, teaching, and discourse. Climate change poses risks to many sectors of the economy. Its physical risks are affecting operations and supply chains, causing disruptions, and affecting operating costs in sectors ranging from agriculture to transportation. Companies also face the risk that laws and regulations will increasingly impose costs on greenhouse gas pollution, forcing that externality into transaction prices, which will alter the competitive landscape in energy and other sectors. And all of these risks have important implications on the financial sector, the investors, lenders, and insurers of these operating companies.

In early 2020, Harvard Business School convened industry experts, HBS alumni, and our faculty members for a conference entitled Risks, Opportunities, and Investment in the Era of Climate Change. In this, and the next three episodes of Climate Rising, we'll hear from financial services experts talking about how they are addressing climate risk in their business, some interesting financial innovations, and their perspectives on the impact of the price on carbon. We kick this off with today's episode, which focuses on leading a financial institution in the era of climate change. HBS professor George Serafeim took the stage of Klarman Hall here on campus to speak with HBS alum, Ronald O'Hanley, the CEO of State Street Bank, one of the world's largest custodian banks, overseeing $32 trillion in assets. Mister O'Hanley's voice on the topic of long-term value and climate change carries significant weight in the industry. Ron O'Hanley addressed the role of The Task Force on Climate-Related Financial Disclosures, or TCFD, the topic of shareholders and proxy voting, and what asset owners can do going forward to make an impact.

George Serafeim:
We want to start the conversation because you have such a unique view of the financial system, leading State Street, that actually touches so many areas of the financial system with a global exchange business, with a global markets business, with a global advisors business, the custody business and so forth. One of the things that we have been hearing is about how increasing regulatory risk, we have gone, just in 15 years, from 8, 7, pricing of carbon across jurisdictions, to about 50, north of 50. So as the regulatory risk is increasing, and as also physical risk and technological risk is increasing, what do you see in the markets in terms of how investors are changing capital allocations?

Ronald O'Hanley:
Well, George, let me begin by saying I want to thank you and thank your colleagues for actually sponsoring this. I look around the room and think that there's 300 alumni here really thinking hard about this topic. And it's a great statement that we are thinking about it because I think it's the most important thing facing investors right now. I think the challenge, even despite what you just described in terms of the trend, which I view as positive, is that, in general, I don't think that climate change risks, and the risks associated with carbon are actually priced into most markets these days. Part of that is because we don't have universal pricing, and there's the possibility or the belief by some that it won't happen in the foreseeable future. You couple that with what I believe is the inherent short-termism in most form of investing, so I think we're in the situation now where you've got, on the one hand, the nature of the liabilities that most investors are trying to solve for are very long-term. And you've got a system of investing, which is inherently short term.

And it's short term in its measurement, short term in how people think about compensation and the way they're remunerated, even short term in the way people think about their own careers, in terms of if I do well in this role, I'm going to get advanced on the next role. It's inherently short term. So this is the complication that we see. And in our role, we play two important roles in this, on the one hand, we're an investor, third largest in the world, and we have a large portion of that in index funds. And if you think about index funds, it's really the closest thing to permanent capital in the public markets. As long as something is in the index, we will be invested in it. So we worry about this a lot because we don't have the option of being able to say, "Gee, we don't like what XYZ company is doing," and turning the S&P 500 into the S&P 499. We have to remain invested in all 500, so much of our stewardship activities is around this, is trying to bring this forward.

The second role we play is we're the largest, or depending on the quarter, largest or second largest servicer of assets in the world. So all these assets that are owned by us and owners, we administer them in some way, $36 trillion worth, in terms of your processing them, measuring them, performance managing them, et cetera. And that's even a bigger problem because the biggest challenge for investors, with all this change going on, is how do I know whether I'm doing well? How do I know whether I'm making the right decision?

In what I call the old way of performance measurement, you picture a horizon, one, three, five year, you decided whether you're going to measure yourself against the benchmark or against peers, and it was pretty straight forward. The only variable might be kind of who are the peers, or might you get really radical and think about a 10 year horizon. Now it has to do with portfolio content, what's in the portfolio, how are we going to work there? So it's become very complicated, but I think it's vital, in our role as a provider and our competitor's role as providers, that we solve this problem and enable investors to be able to invest with climate in mind.

George Serafeim:
And you touched on measurement. You mentioned measurement. And measurement is something that everybody complains [about] in this space. Now, we have reasonable data on Scope 1, Scope 2 emissions, for example. The Scope 3 data is not there, and it's very, very complicated how to even measure that. What do you see as what do we need to have in terms of new data, new analytics, and new financial products in an era of climate change?

Ronald O'Hanley:
I mean clearly more data would help, but even just full adoption of some of the standards and approaches that are out there now. So TCFD, for example. We can all complain about it, and it's certainly not perfect, but you got to start somewhere, right? And if you go back in deep history in the '30s, I mean even FASB and some of the common accounting standards was thought to be radical, but we need to start somewhere on this. So I think almost insisting on adoption of this, and I think this is where the role that the asset owners can play, because ultimately it's their money, and they're the ones ... I mean in some ways we're just the agent. It's their money, and insisting upon we're not going to make an investment unless we have proper disclosure ...

I mean we wouldn't make an investment in a public company if we didn't have certified financial statements. Why wouldn't we insist on, for example, having TCFD fully adopted? So that would be one. But secondly, I do think there's much more that can be done on data. Again, driven by what investors want. I think you will see more data sources coming available, but it's got to be driven by the asset owner and the asset manager saying, "We're not going to go forward unless we have this data, and we're able to use this with you."

George Serafeim:
How are you thinking about the issue of carbon tax and carbon regulation going forward? How are you preparing State Street, thinking about your own organization, in terms of your expectations in the next 5 to 10 years? Do you see an increased probability of getting towards a global price on carbon? And if yes, how fast and how much?

Ronald O'Hanley:
That's a complicated question. Let me just take it apart a bit. I don't think that the world can proceed forward unless we have a global price on carbon, and global pricing mechanisms. I mean you've got just incredibly distorted kind of policies in place. I mean any economists will tell you if you don't fully price in the externalities, that we're not able to get the proper and appropriate economic behaviors. So we, from a policy perspective, feel that this is a threshold issue and needs to happen. The question is when it will happen. And I think there's lots of obstacles to it. There's politics, and not withstanding Chatham House Rules, I'm not going to go there, but there's the political situation in the US, which I think eventually will unlock, but I think in the short term probably won't. I think the other very real issue is how you think about the transition to this. On the one hand, the carbon problem is truly a global problem. We should care about what's going on in India. We should care about what's going on in China. And I think the way it gets solved is globally.

On the other hand, you've got real transition issues for some of these developing economies. And I actually buy the argument that okay, you, the developed world, kind of had your chance. You did what you did in, terms of disrupting the environment, and why are you telling us we can't do it? Now, we know why they shouldn't be doing it, because we just know better than we knew 100 or 150 years ago. But I think at some level we need to think about, and I'll use the dirty word, subsidy. How do you, in the transition, make sure that developing markets actually are treated fairly and are able to develop, not held back in their development, as part of this transition? But getting back to your question, we do see this coming, both as investors, and frankly as a corporation. We think about climate along four dimensions at State Street. I've given you two. One is as an asset manager, second as an asset servicer.

Third, we're a corporation. And we live in this world, and we're driving ourselves towards first carbon reduction, and then second to carbon neutrality. And it's hard work, but actually when you apply yourself to it, at least for a financial institution, it's not that hard. We're going to get there much sooner than we expect it to be. And then the fourth dimension is just as a member of the community. I mean we tend to be a large player in the communities that we're in. Our employees live in these communities. We want to see these communities thrive. So for us, we see this coming, we're supporting the coming of it, and I think, for most of us, we can probably say that, yeah, on the one hand, we're going to pay more for this, but then there's going to be more opportunity coming out of it, and we see bright, new investment opportunities out of this. So that's where we are.

George Serafeim:
It's very interesting that you mentioned the word opportunity. Just two days ago, I was teaching my class, and I was teaching a case on a big chemicals company in Europe. I think I mentioned that to you a little bit. And the CEO of the company was there, and I mentioned what are the implications from a carbon tax? And we got pretty fast to the fact that it would add about 700 million in cost for the company. And it was almost impossible to get to the point that actually it would generate about 4 billion in revenues. Because when you mentioned about the tax, everybody's thinking about cost, but actually it's an opportunity for the management teams that have positioned companies to be competitive in this low carbon era.

Ronald O'Hanley:
Yeah, I agree with that. I also think that the way this will play out is that any time somebody suggests a new cost or some kind of broad based tax, of course, there's a lot of resistance, and that tends to be enabled by certain political systems too. But I think we're going to very quickly get to the point where the uncertainty around the tax is actually going to be more painful than the tax. And as you start to see, particularly for global companies, that this mechanism is being imposed around the world, and then there's this question about whether or not the US is going to do it, I think at some point the uncertainty around that will be more painful.

I mean the analogy here is around the fiduciary role, for those of you that follow that. There was a lot of opposition to the fiduciary role, and then it was pushed through. And we can all question whether or not the rule made sense, but it gave some certainty. And then, in fact, when the Trump administration came in and started talking about rolling it back, it was interesting. All those that had actually opposed it before said, "No. One we've already done it. And two, we finally have certainty. We know where we're going." So I think that the uncertainty around what's going to happen with carbon pricing may be our best friend here.

George Serafeim:
You wrote a recent letter to the editor in the Wall Street Journal distinguishing between values driven investing versus value driven investing, why it's so important for a long-term investor to actually focus on sustainability. Tell us a little bit about that, because I think this is something that is a little bit of a misconception in many people's minds. Give us a little bit of rationale for that.

Ronald O'Hanley:
Yeah. I think this is an important distinction to be made. We focused on value or we focused on values. And the letter that George is referring to was, if I recall, when Larry Fink, of BlackRock, published his latest letter to CEOs. There was a lot of criticism, and the basic criticism was that why should investors be imposing their values on whether it's in individual companies or actually the investors on whose behalf they're operating. And I can't speak for Larry, but I do think that what BlackRock is doing is not dissimilar to what we're doing. This is about value. And we particularly, as I said, as long term investors, think that climate is extremely important to understanding the long term value prospects of individual companies. And that's what this whole impetus is around. It's not about saying we're going to preach to you about what you should be doing, whether it relates to women on boards or climate, this is not about values.

We may share those values, but what my values are, what Larry's values are, actually aren't relevant. But it's about value, and how you're creating value, how you're ensuring that the companies in which you're investing are creating value. And that's the whole focus of this. And I think we've allowed the dialogue to get out of control here, and we've lost the dialogue and control of that, that somehow those of us that are really thinking about this and investing this way are imposing their values. It has nothing to do with that. I mean I always use the example of coal. Coal reached peak market capitalization in 2011. And four years later, most of those, or several of those companies, at least in the US, were bankrupt. And now I've learned last night, they've taken another step down. So the point being, it's about value. Whether or not I believe that coal is a good thing or not from a values perspective is irrelevant. It's how do we think about long term shareholder value?

George Serafeim:
Thank you, Ron. Questions from the floor.

Speaker 4:
You spoke a little bit about how investors can insist that companies give better disclosure and adopt environmental standards as a condition for investment, but could you talk a little bit about the leverage you have as a manager of ETF, a passive investment in that? Because you do have to invest across the index, so you can't make the threat of not investing in a company, so what are the leverage points that you have with companies in that sense?

Ronald O'Hanley:
Yeah, I mean that's right. If you're managing, whether it's an ETF or even a separate account to an index, you're basically bound to invest in that index. On the other hand, one could define the index as it needs to be constituted of companies that do this and provide these disclosures. So I don't think that's that big of a leap. I mean that's not our role in the ecosystem here, but could S&P, or S&P Global, or MSCI impose that? Sure they could. I don't think that's that hard a leap. And again, this will happen if the ultimate investors insist on it. So if the asset owners and the retail investors of the world insist on it, this will happen.

Speaker 5:
My question is also related to stewardship, but specifically shareholder proposals and devoting of proxies on behalf of clients, because one of the reasons that Larry Fink was criticized is because he was espousing, perhaps, a certain set of ideals, but when you examined the proxy voting history of BlackRock, there was really a lack of alignment there. And so I'm wondering how you at State Street deal with the issue of voting proxies, particularly given the emergence of shareholder proposals on highly controversial issues, on everything from artificial intelligence to pay equity to a whole host of ESG related issues. So if you could address that, I would appreciate it, in the context of your fiduciary duty.

Ronald O'Hanley:
So going back to the prior question, I mean part of our stewardship is very much around shareholder proposals. We look and evaluate all of them and, with all due respect to those that are putting the shareholder proposals forward, a lot of them don't make sense, or when you look at them from an evaluation perspective, they actually don't represent even a small minority of what shareholders do. So we look at them all, and we make a judgment on what makes sense for the longterm value of the company here. Problem with a lot of shareholder proposals is they have great headlines that are associated with them, but when you actually look at what the proposal is, or what the consequences or implications of actually adopting it would be, they actually have some negative value, not values, implications for the company. So we've all been criticized for our voting record, but I stand by what our team does. They look at them all. When it makes sense, they vote for them. And when it doesn't, they don't, with this lens towards what's right for long term value.

Speaker 6:
Ron, you mentioned that the shareholder proposals are poorly structured, and worded, and not really getting to the point, but I do agree that State Street has better analysts that can actually determine value from values. Why doesn't State Street participate in the formation of shareholder proposals themselves, ones that they could actually vote for, and lead the way as opposed to letting the Sisters of Charity try to show you how to change the world?

Ronald O'Hanley:
Yeah, it's an interesting point that we've actually started to debate internally. Is that a role that we might play here? I mean we have to be careful in that because ultimately there's probably 7,800 different companies that we invest in around the world, so how would we think about that and what would we do? But we've just started to think about that, because your point's well taken. And it's not just us, the Vanguards, BlackRocks of the world probably are in a position where they could craft good shareholder proposals. So it's something that's on our mind.

George Serafeim:
Ron, thank you very much for being here with us today.

Ronald O'Hanley:
Thanks George.

Mike Toffel:
That's it for this episode of Climate Rising. Next time-

Speaker 7:
If you believe in climate change, but don't take that into your portfolio management, I don't think you are satisfying your fiduciary duty. We only be able to make our portfolio sustainable for longterm by making the whole world more sustainable.

Mike Toffel:
Thanks for joining us. I'm your host, Mike Toffel. This is Climate Rising, a podcast produced by the Business & Environment Initiative at Harvard Business School. You can subscribe on Apple podcasts, or wherever you listen, and please leave us a review. We appreciate the feedback. You can also find show notes and links to resources discussed on this episode on the Climate Rising website, climaterising.hbs.edu.