The political battle is intensifying over whether it makes financial sense to consider a company’s impact on climate change, workers’ rights and other issues when investing.
Republicans from North Dakota to Texas are mounting criticism of “ESG investing,” a fast-growing movement that says it can pay dividends to consider environmental, social and corporate governance issues when deciding where to invest pension and other public funds. simultaneously, Democrats traditionally blue states like Minnesota are considering making ESG principles an even more important part of their investment strategies.
In ESG, the E component, which stands for “environment,” often gets the most attention because of the debate over whether to invest in fossil fuel companies. In the broad range of social, or S, buckets, investors look at how companies treat their workforce, thinking that a happier group with lower turnover might be more productive. On the G, or governance aspect, investors are looking to ensure that company boards hold executives accountable and pay CEOs in ways that drive the best performance for all stakeholders.
The ESG industry has experts who assess how well companies are handling such environmental, social and governance issues. Poor performance can drive investors away from companies or governments that are seen as riskier, but it can also make it more expensive for them to borrow money and hurt them financially.
Florida has become one of the hottest battlegrounds for ESG. Gov. Ron DeSantis in August banned public fund managers from using ESG considerations when deciding how to invest public pension plan money. And even as his state cleans up from the environmental devastation caused by Hurricane Jan, DeSantis plans to address the Florida Legislature in 2023 to go even further by banning “discriminatory practices by major financial institutions based on ESG social credit scores.”
Pension funds are often at the center of battles. Teachers are fielding questions at the Florida Education Association about what DeSantis’ moves will mean for their retirement.
“I usually tell them it’s still unclear what that means,” said Andrew Spar, president of the union that represents 150,000 teachers and educators statewide. Much remains to be determined, including which funds pension investments will be directed to.
In contrast, the Minnesota Investment Board is considering a proposal to adopt a goal of making its $130 billion pension and other funds carbon neutral. Boards of directors are already using shareholder votes to advance climate issues. It looks for climate-friendly investment opportunities and avoids investing in thermal coal. While the new proposal goes further, it falls short of the complete divestment of fossil fuel companies that many climate change activists advocate.
The ESG debate spilled over into the race for Minnesota state auditor. Democratic incumbent Julie Blaha — who singled out DeSantis as one of the leaders she sees as politicizing the ESG debate — cited the investment board’s strong returns in recent years as proof that the approach is working.
“To be a good fiduciary, you have to consider all risks, and there is clear evidence that climate risk is an investment risk,” Blaha said.
But Blach’s Republican challenger, Ryan Wilson, says that investment returns should come first and that all risks should be considered. He says the council should not “disproportionately mandate” that climate risk should be given more weight than other risks.
Proponents say that considering a company’s ESG performance can improve profitability and limit losses in the long run while maintaining social responsibility. Using such a lens, they say, investors can avoid companies that are riskier than they appear on the surface, with too high share prices. An ESG approach could also open up opportunities that may be undervalued by Wall Street, they believe.
In terms of profitability, there is no consensus as to whether an ESG approach means lower or higher profitability.
Morningstar, a company that tracks mutual funds and ETFs, says just over half of all sustainable funds ranked in the top half of their category in terms of returns last year. In five years, the show is better, with almost three-quarters ranking in the top half of performers in the category.
Forgoing ESG can be costly in more than just investment terms.
The Texas law, which took effect in September 2021, prohibited municipalities from doing business with financial institutions that have ESG policies against investing in fossil fuel and firearms companies, which are important industries to the Texas economy. This turned out to be an expensive decision.
The five major underwriters — JPMorgan Chase, Goldman Sachs, Citigroup, Bank of America and Fidelity — are barred from underwriting local jurisdictions’ municipal bonds and have left those markets. A Wharton School study estimated that losing these big players would cost Texas communities an additional $303 million to $532 million in higher interest payments on their bonds.
Several large Wall Street banks and investment management firms have become favorite targets of anti-ESG politicians because they are openly pro-ESG. The Republican state treasurer has pulled or plans to pull more than $1.5 billion this year from BlackRock, the world’s largest investment firm, which has a goal of net zero greenhouse gas emissions by 2050 or sooner. The last month was Missouri. Treasurer Scott Fitzpatrick accused BlackRock of putting “an awakened political agenda ahead of its clients’ financial interests.”
Coal-producing West Virginia passed a law in June that would allow banks and other financial institutions to be barred from doing business with the state if they “boycott” energy companies. Treasurer Riley Moore soon banned BlackRock, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo, accusing them of contributing to high energy prices by draining capital from the industry.
“We are not going to pay for our own destruction,” Moore said.
Government officials have also been critical of ESG ratings from rating agencies and other companies. For example, S&P Global offended North Dakota State Treasurer Thomas Biddle because he rated the state as “neutral” on social and governance metrics, but “moderately negative” on environmental factors because its economy and budget are heavily dependent on the energy sector.
Lawmakers in his state last year barred their investment boards from considering “social responsibility criteria” for anything other than profit maximization. Biddle told senators considering possible next steps that ESG has created “significant hurdles” for energy companies trying to raise capital and that it could affect his state’s tax revenues.
Besides state capitols, other major battlegrounds are federal agencies, where leaders of the backlash include the Public Finance Officials Foundation, a group of Republican state treasurers, auditors and other officials. They are trying to block rules being drafted by the Securities and Exchange Commission and the Department of Labor to require standardized climate disclosures from companies and to make it easier for pension plan fiduciaries to consider climate change and other ESG factors.
The industry heard the pushback and was even surprised at how quickly it accelerated. But it promises to move forward.
The US SIF is an industry group that advocates for sustainable investing, with members overseeing $5 trillion in assets under management or advice. Its CEO, Lisa Wall, believes that most national and state politicians who oppose ESG investing probably don’t get it.
“If they did it, it’s very difficult to make accusations like that,” Wohl said. “It feels more like a talking point than an informed critique.”
Choe reported from New York.