The fight is on. In this corner, we have self-serving alliance of US Senators who voted to reverse a rule that permits retirement plan managers to factor in environmental, social, and governance-oriented (ESG) considerations into their investments. In the other corner, we have the resident of the White House executive office, who has threatened to wield his first veto of the year to prevent this attempt at blocking ESG investments.
The Senate passed the ESG blocking measure after Senators Jon Tester (D-Montana) and Joe Manchin III (D-West Virginia) crossed party lines and joined the Republicans, providing the key pieces of the 50-46 majority needed. Both senators are up for reelection next year in heavily Republican states.
The rule allows retirement funds to consider climate change and other factors when deciding on which investments make sense. The Biden administration enacted the rule as a balance to a 2020 Trump rule that sought to limit the ability of retirement and pension plans away from fossil fuels.
The bill falls under the Congressional Review Act, which allows Congress to retract rules issued by a federal agency provided the rule has not been in effect longer than 60 legislative days.
If Biden vetoes the measure, a two-thirds majority of Congress would be needed to override his action.
Responsible Financial Planning or Not?
Responsible investing – the practice of incorporating ESG factors into investment decisions – has become quite common. And it’s not like ESG investing is new; it’s been around for nearly two decades. Lots of major global corporations readily accept its inherent principles.
Excluding brown industries – such as tobacco, gambling, and fossil fuels – is often perceived as the purest and most effective form of responsible investing. Divesting starves these industries of capital, limiting additional harm. By refusing to endorse their goods and services, practitioners and the public hold investors accountable for holdings of brown firms and call for management companies to commit to divestment.
The sought-after result of ESG investing is that brown companies take corrective actions to minimize the harm they create. For example, fossil fuel firms can develop renewable energy divisions and reduce their overall carbon footprint. The prize for corrective action via sufficient incentives to reform is, of course, investor promises for greater purchases upon a positive ESG rating.
Corrective action incentives take patience and nuance. Instead, the Senate this month chose to engage in stark and divisive culture wars.
Culture Wars & Hitting Each Other Where It Hurts
The culture wars that permeate US politics have seeped into the financial world. This week Congress allowed through a measure blocking ESG investments, and Biden finds himself in the precarious position of needing to counter the hazy edict. In the past year, ESG investing has become caught up in US culture wars, as GOP politicians stake their reputations and warn of a “woke” ideology on companies.
As a component of an expansive Republican political strategy, the vote works to portray Biden as extreme liberal run amok and whose administration inserts progressive values into unwanted areas of US life. Senate Minority Leader Mitch McConnell (R-Kentucky) said that “the Biden administration wants to let Wall Street use workers’ hard-earned savings to pursue left-wing political initiatives.”
Caught in the middle of this dispute are asset managers BlackRock, Vanguard, and State Street. They collectively oversee more than $20 trillion in assets and cast more than a quarter of all votes at S&P 500 companies. Those in the anti-ESG crowd say these firms are prioritizing politics over returns, according to a Washington Post editorial, “reflecting the undue influence of pension funds and foreign interests that themselves pursue an anti-United States and anti-capitalist agenda.”
Senator Sheldon Whitehouse (D- Rhode Island) insists the GOP backlash to the bill is misguided. “The Republicans would like us to believe that some bizarre viral epidemic of wokeism has spread into America’s great financial companies, into the investment advisers, into the banks, into all kinds of fiduciaries, and that needs to be somehow excised,” Whitehouse states. “That is not what has happened.”
The opportunity does exist to work toward a bipartisan consensus that will take the political passion out of ESG. With Biden as the consummate consensus-builder, it is possible, especially if state legislators are brought into the fold.
What about Red State Governors & ESG Investing?
Not all Republican leaders are pushing to outlaw ESG investing. Several governors who are looking ahead to upcoming campaigns for higher office recognize that strident positions can turn off some constituent voters.
The Biden-Harris’ Administration’s Inflation Reduction Act (IRA) will drive roughly $369 billion to climate-related initiatives across the US. That’s a huge influx of funds for states, and it’s had surprising results. The federal endorsement of sustainable investments is actually prompting some red state legislators to embrace ESG positions. Some key red state legislators have hit pause on proclamations to eliminate ESG investments. Governor/ candidates see financial considerations that take into account non-financial information about a company, such as its climate impact and staff diversity, as popular with voters.
They’re walking a proverbial fine line as they maintain their party funding sources — they’re resorting to the original and narrow intention of ESG investing. The Harvard Business Review (HBR) defines this as a means for helping companies identify and communicate to investors the material long-term risks they face from ESG-related issues like climate change. The HBR authors argue that “the role of Congress is to provide oversight of the rulemaking process as the SEC determines which risk factors are material to investors and balances the need for disclosure with the cost to companies of providing the information.”
Prudent governors recognize that, for markets to properly allocate capital, investors need companies to disclose material investment risks. Investors with trillions of dollars in assets under management as well as a fiduciary duty to maximize long-term risk-adjusted returns regard how a company is managing the effects of climate change to be a material issue. Despite the victory in Congress for critics of ESG, members of state legislatures around the country, including Republican strongholds, have balked at interfering with investment decisions by major financial institutions, in part because such restrictions cause substantially high borrowing costs.
Of course, not all environmental claims are equal. Awareness is growing about greenwashing, and climate advocates are calling for regulators to step up and provide a uniform interpretation of what’s an environmentally sound policy and what’s not. Until ESG reporting is based on a set of standards, called metrics, greenwashing and boastful marketing may substitute for real sustainability indices and further mask fossil fuel investments.