ESG, Sustainability

The Anti-ESG Investment Backlash

The trend to invest in companies dedicated to environmental, social, and governance (ESG) issues continues to explode.

ESG and investments

ESG as a concept is an evaluation of an organization’s collective consciousness for social and environmental factors. More specifically, it is a metric to assess an organization’s impact beyond its internal mission-driven operations and financial performance.

The U.S. Securities and Exchange Commission (SEC) recently provided an overview describing a range of factors that ESG can encompass from an investor’s perspective:

  • Environmental: a company’s impact on the environment, the risks and opportunities associated with climate change, and its impact on an organization’s business and industry;
  • Social: an organization’s relationship with people and society in terms of diversity, equity, and inclusion (DEI); safety and health; human rights; and community investment; and
  • Governance: the way a company is run in terms of its transparency and reporting, ethics, compliance, shareholder rights, composition, and the role of the board.

The theory is that the companies that align with ESG values, including both for-profit and nonprofit organizations, are likely to outperform in their respective markets.

Globally, lawmakers are enacting regulations to ensure investment managers are not “greenwashing” investment products by overemphasizing ESG features. “In Europe, ESG investment products are subject to disclosure requirements coming from the Sustainable Finance Disclosure Regulation, and the U.S. Securities and Exchange Commission (SEC) has proposed its own rules regarding the disclosures required for U.S. mutual funds and conditions under which such funds can adopt names suggesting an ESG focus,” reports Reuters.

The backlash

Now, in the United States, states are enacting their own rules regarding ESG investments.

“Some of these states are using their legislative power to limit ESG investing, citing concerns that ESG investing is putting policy and social objectives ahead of financial objectives, or even concerns relating to the impact ESG investing could have on their local economies,” Reuters adds.

In 2021, Texas became the first state to pass anti-ESG legislation. The state utilized the anti-boycott format, which means local authorities are barred from doing business with banks utilizing ESG policies to move away from investing in fossil fuel-based energy companies. Another way of stating this is that Texas won’t utilize banks that are boycotting oil and gas companies in any way.

In testimony before the Texas Senate, Dr. Brent Bennett, director of Life-Powered, stated, “[O]ne solution is to turn the tables on the banks. If they will not do business with us, we will not do business with them. Right now, the large banks and investment firms are being rewarded instead of penalized for divesting. However, if energy producing states refuse to invest in these firms, then they will face a real financial penalty for their actions. Our energy businesses contribute tens of billions in tax dollars every year to our state, and those tax dollars should not be given to firms that are actively seeking to punish those businesses.”

Within the last year, “18 states have proposed or adopted state legislation or regulation limiting the ability of the state government, including public retirement plans, to do business with entities that are identified as ‘boycotting’ certain industries based on [ESG] criteria,” says an October 13, 2022, Morgan Lewis article in Lexology.

Four states have recently proposed or adopted regulations or legislation to restrict ESG activities. These states are Arizona, Indiana, Louisiana, and Pennsylvania.

Anti-ESG actions include:

  • Boycott Bills. According to Morgan Lewis, Boycott Bills “target ‘financial institutions’ that ‘boycott’ or ‘discriminate against’ companies in certain industries and prohibit the state from doing business with such institutions and/or investing the state’s assets (including pension plan assets) through such institutions.” Often, the companies being “boycotted” or “discriminated against” are energy companies, specifically those that rely on fossil fuels, as well as mining and lumber companies.
  • “No ESG Investment” regulations. Such regulations prohibit the use of state funds for ESG investment. “The state would be specifically prohibited from investing in strategies that consider ESG factors for any purpose other than maximized investment returns,” adds Morgan Lewis.
  • Position statements. In some instances, state officials (e.g., state treasurer or state attorney general) will issue a statement, letter, or written opinion stating that ESG investing is contrary to state law. Obviously, position statements are not as binding as laws or regulations, but they serve to clarify the state administration’s stance should further action be necessary.

Morgan Stanley notes that Pennsylvania is pushing the Boycott Bill a step further than mentioned above, as a bill was recently proposed that seems to prohibit any company from operating in the state if it discriminates based on ESG factors.

For a complete list of anti-ESG legislatives and administrative mandates, including Boycott Bills against energy companies proposed or adopted in 18 states, see Morgan Lewis’s summary chart.