ESG News 2022: ESG Backlash and the Politics of Sustainable Investing
According to an investigation published by the New York Times on August 5th, a coalition of Republican state treasurers is working to penalize financial institutions that move to divest from fossil fuels (and from firearms). This ESG backlash is both highly politicized and well organized.
Selecting investments in companies that are carefully considering the environmental and social contexts in which they are doing business while treating shareholders fairly is known as Environmental, Social and Governance aka “ESG”. Sustainable investing uses ESG criteria to seek out potential investments, as well as to reject unacceptable ones.
Sustainable investing is not meant to be political, despite its origins in the anti-war and anti-apartheid movements. The goal is to do well by doing good, to enable investors to generate attractive returns while aligning their investments with their values. In essence, sustainable investing is a long-term-oriented strategy based on fundamental analysis. Who could argue with that?
Yet we are seeing a lot of ESG backlash from politicians in “red states” who are going after sustainable investing. Recently “Florida Governor Ron DeSantis criticized ESG investing and companies including PayPal Holdings Inc., saying he would work with the state legislature to battle what he called a “woke ideology” being promoted by Wall Street banks, asset managers and big tech companies.” (Bloomberg). In May former Vice President, Mike Pence, denounced ESG investing in a Wall Street Journal opinion piece as a radical strategy of “far-left extremists” seeking to take away Americans’ freedoms. Many other red state politicians have voiced similar opinions.
It’s Not Just Talk
The attack on sustainable investing first turned from rhetoric into action in 2020 when the Trump Administration’s Department of Labor finalized new rules requiring that managers of private sector pension funds select investments “based solely on financial considerations”. Since ESG criteria were considered by the new rules to detract from investment returns, strict new requirements to justify the inclusion of ESG options in retirement plans were established.
The ESG backlash continued as the Trump Administration also moved to severely limit the ability of pension funds to put forward ESG-related proxy resolutions at corporations’ annual meetings. These rules were finalized despite intense criticism during the required public comment period. The clear aim was to establish that pension plan managers were at risk of violating their fiduciary responsibility to beneficiaries if they included ESG considerations in their decision-making. The Biden Administration declared that it would not enforce these new rules and would be “revisiting” them.
The attack was not limited to restrictions on ESG investing but extended to shareholder rights more generally. Under the Trump Administration, the SEC (Securities and Exchange Commission) implemented rules limiting the ability of independent advisors such as Institutional Shareholder Services (ISS) to provide guidance to shareholders ahead of proxy votes. Many big investors rely on this guidance when deciding how to vote on shareholder resolutions proposed by company management or by independent shareholders. The goal of these changes was to make it less likely that shareholders would vote against company management at annual shareholder meetings. After ISS sued to reverse the new rules, the SEC voted in July 2022 to rescind them.
Now Red State Politicians Are Taking Action Against Sustainable Investing
At the Federal level, ESG backlash and the attack on sustainable investing have passed, at least until the next Republican administration. Since 2020, however, elected officials in several states have passed legislation or implemented regulatory changes that take direct aim at it.
In June of 2021, the Texas state legislature reacted to announcements by Citigroup, Bank of America and giant fund manager Black Rock that they were moving towards divesting from the fossil fuel sector by banning all Texas state and local governments from doing business with them and with any other financial firm that divests from fossil fuels. The most important effect of this legislation is that the very large Texas municipal bond market is now closed to these institutions. Additionally, no public sector pension fund in Texas can do business with an investment manager that has divested from fossil fuels.
The same month the Texas legislature banned state and local governments from doing business with banks that do not provide financing to gun manufacturers, as several have already stopped doing.
According to the NY Times investigation, Republican state Treasurers are working with organizations such as the State Financial Officers Foundation, the American Petroleum Institute, the Heritage Foundation and the climate denialist Heartland Institute to block efforts by the financial sector to combat climate change. The American Legislative Exchange Council (ALEC) has prepared a legislative template based on Texas’s new law penalizing financial institutions that divest from fossil fuels. West Virginia, Kentucky, Oklahoma and Tennessee have already passed the measure, which several other states are considering.
In July of this year, the Treasurer of West Virginia announced that Black Rock, Goldman Sachs, JP Morgan Chase, Morgan Stanley and Wells Fargo were blacklisted from doing business with the state because they are reducing financing to the coal industry. Louisiana and Arkansas have also pulled state money from Black Rock, the world’s biggest investment manager. Black Rock has become a prime target of red state politicians due to its outspoken support of sustainable investing, even though its rhetoric has gone much farther than its actions, as discussed in my recent article on “greenwashing”.
Why Is There So Much ESG Backlash and How Did Sustainability Become So Political?
Not all that long ago environmental protection was a bipartisan issue. Under Republican presidents, the US created the Environmental Protection Agency, the cap and trade mechanism that successfully reduced sulfur dioxide emissions that were creating acid rain, and the Montreal Protocol to phase out CFCs and save the ozone layer. The first Bush administration participated in the Rio de Janeiro summit that launched the global effort to combat climate change.
And when Ronald Reagan was Governor of California both he and the NRA supported gun control.
What happened? Money combined with the culture wars to politicize what had been a bipartisan set of issues. The economic interests of the fossil fuel and firearms industries are threatened by the sustainable investing trend and they have naturally been lobbying hard to protect themselves. Oil and gas are very important to the economies of Texas, Louisiana and Oklahoma, and coal remains totemic in West Virginia, even though it employs only 25,000 people in the state these days. These economic – if shortsighted – arguments have been infused with resentment of so-called “elites” by opportunistic politicians.
A less overtly political argument made by opponents of sustainable investing is that applying ESG criteria will hurt investment returns. As I have discussed elsewhere, there is ample evidence that this is not the case. In fact, when Harvard University’s endowment announced that it was divesting from fossil fuels, the university stated that it was purely for fiduciary reasons: their analysis was that investing in fossil fuels would hurt their long-term returns.
So far, those backing the boycott of financial institutions that are trying to become more sustainable are shooting themselves in the foot. In July, the Houston Chronicle reported that the ban on doing business with banks that don’t do business with gun manufacturers has already cost Texas municipalities over $500 million in extra fees. With fewer banks competing for municipal bond business in Texas the remaining institutions are able to charge more.
Will Political Backlash Stop Sustainable Investing in Its Tracks?
The ESG backlash is fierce and well-organized. So far, at least, banks and fund managers have largely chosen to give up on doing business in Texas and other states rather than anger their other stakeholders by reversing their fossil fuel and firearms divestment strategies. As the backlash continues it will become more and more difficult for financial institutions caught between their own commitments to do more to combat climate change on one side and some of their large clients on the other. Fortunately for Black Rock, it is so enormous that even losing the public pension fund business of Texas and other red states will only make a small dent in its revenues.
In contrast to Texas and its red state allies, the public pension funds of blue states such as California and New York have continued to move forward with divesting from fossil fuels. The support of these very large investors, coupled with pressure from activist shareholders, should help keep the financial industry on its current path of gradually divesting from fossil fuels and firearms. And, of course, climate change and gun violence are not going to go away just because red states deny that they are problems.
Ironically, the financial sector has only just begun to address climate change and other sustainability issues. The commitment to ESG of the big institutions that the red states are targeting has largely been rhetorical so far. Those of us who are committed to sustainable investing need to keep up the pressure so that the backlash does not succeed.
Urban Larson
Principal
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