Boycotting the boycotters: How ESG investing became a battle, pitting red states against blue
In his inaugural address on January 20, 2021, President Biden called for unity: “We must end this uncivil war that pits red against blue, rural versus urban, conservative versus liberal”. Yet, the already stark political divide between blue and red states has only grown wider since, reaching new extremes. It is no surprise then that the latest controversy pitting red states against blue states, and red states against the Biden Administration, involves sustainable finance.
Sustainable finance can be defined as the process of integrating environmental, social and governance (ESG) considerations into investment analysis and decision-making. Policy makers view sustainable finance as a tool for channeling private investment toward greener, socially sound and resilient economic activities and, therefore, facilitate the transition to a carbon neutral, more inclusive, economy. Sustainable finance also serves the purpose of managing risks related to ESG factors in the financial system by pushing corporations to measure their impacts and act more responsibly.
In recent years, interest in this type of investment choice has increased exponentially. However, one challenge is to avoid a widespread tactic known as "greenwashing" by which companies make false, unsubstantiated, or misleading claims about the impacts of their products, services and business operations on people and the environment to gain or maintain market shares and access to capital. Only if the information provided to consumers and investors is truthful, relevant, consistent and comparable across companies ESG funds can deliver durable and meaningful results.
Under the Biden Administration, the Securities and Exchange Commission (SEC) has begun a process of standardization of ESG disclosures to promote consistent, comparable and reliable information for investors concerning the incorporation of ESG factors in investment funds and strategies. It includes climate-related disclosure rules for public operating companies and a series of SEC staff risk alerts, press releases, commissioner speeches and reports, other public statements, and enforcement activity that together demonstrate an intense focus on greenwashing regarding the extent to which ESG factors are employed in investment products marketed to investors.
Against this backdrop, ESG investing is attracting numerous enemies. Among them are nineteen U.S. attorneys general from mainly Republican-led, energy-producing states (including Montana and West Virginia) who recently penned a letter accusing the world’s largest asset manager, Larry Fink, of pursuing ESG investment policies to the detriment of their state pension funds.
Two frontrunners in the anti-ESG movement are Texas and Florida. In Texas, the legislature released in late August a list of 10 financial firms and roughly 350 investment funds it deems to be boycotting energy companies clearing the way for Texas officials to bar them from state business. In Florida, Governor Ron DeSantis, along with other trustees of the State Board Administration, passed a resolution that directs fund managers of Florida’s pensions to invest state funds in a way that prioritizes the highest return possible without considering ESG criteria. DeSantis intends to work with lawmakers to pass legislation to battle the “woke ideology” that, according to him, punishes conservative Americans. He is not alone in taking the position that ESG is a socialist plot by a group of “corporate elites” disguised as free market.
One possible explanation for this lamentable state of extreme polarization is that blue states stand to benefit more as the nation transitions into a high-productivity, 21st-century information economy, while red states (apart from their major metropolitan centers participating in that economy) are suffering as the powerhouse industries of the 20th century—agriculture, manufacturing, and fossil-fuel extraction—decline. Through several spending bills, the Biden Administration is doing everything it can to ease the transition to renewable energy sources and revitalize local economies, particularly in states that are falling behind. Anti-ESG initiatives mirroring the ones in Texas and Florida in about a dozen other states are detrimental to the people of those states and potentially dangerous to our financial system.
SEC Chair, Gary Gensler, has noted on multiple occasions that the SEC is not a merit regulator meaning that investors are free to choose what they want to invest in and how much risk they want to take. However, to do so rationally and effectively they must have access to adequate and accurate information. Conservative leaders who claim to support individual liberties above all else are, in fact, ostracizing the freedom to invest and some, like DeSantis, are violating their fiduciary duties. They are mismanaging public funds to the tune of billions of dollars while hurting retirees, firefighters and school teachers. For their part, the “boycotters” do not seem eager nor very effective at boycotting after all: Mr. Fink publicly stated that that’s not what his firm, Blackrock Inc., is doing nor his intention. Data suggests that financial institutions overwhelmingly continue to support fossil-fuel investments and ESG funds don’t necessarily correlate with firms’ compliance records or actual levels of carbon emissions.
If we are to succeed in managing climate risks, both in the real economy and within the financial system, markets need tools to combat greenwashing as a matter of public policy. Some scholars have argued that, in fact, it’s a corporation's duty to sacrifice short term gains to maximize the long term health and prosperity of its business. Federal standards exist to provide a minimum level of protection to all citizens across the nation. Within a common floor, states have room to innovate further and showcase what’s possible. In implementing federal mandates, states typically retain a margin of discretion. Some states whose local economies are more diversified and less reliant on fossil fuels have taken ambitious steps to decarbonize; other states at the opposite socio-economic spectrum may require greater federal assistance and choose different paths and timelines but the bottom line for all states is to allocate scarce resources efficiently and transparently while protecting consumers, investors, and workers.
In the long run, managing climate-related risks is in everyone’s best interest. Republican governors should welcome ESG investing in their states and strive to improve it, not use cheap ideology as a substitute for serious policy making for their short term political gain. The ballot box may be the judge of the anti-ESG movement come November.