Interest in ESG investing continues to attract attention globally as policymakers and regulators around the world implement policies and regulations to direct or guide behavior and protect the interests of a wide range of stakeholders. Against this backdrop, we observe a rising challenge to so-called “woke capitalism”, particularly with the recent wave of anti-ESG sentiment building in the US.
In a previous blog post, we considered a new Texas statute (Tex. Gov’t Code sec. 809.051) prohibiting state investment in financial companies that “boycott” certain energy companies based on ESG metrics, as well as other potentially “anti-ESG” initiatives by lawmakers in other US states.
Recently, Florida announced proposed legislation that would prevent state fund managers from considering ESG factors when investing state money and prohibit discriminatory practices by financial institutions based on ESG social credit score metrics. Rather, institutions would only be allowed to invest with the goal of “maximizing financial return” (i.e., profit as the only measure). Florida joins a growing list of states – including (as noted in our previous blog post above) Texas, Oklahoma, Kentucky, Ohio, Arizona, Idaho and West Virginia – that have proposed or enacted what is being labelled “anti-ESG” legislation aimed at deterring or eliminating ESG considerations when investing state funds.
While the nature and scope of anti-ESG policy proposals may vary, they tend to fit into one, or both, of two broad categories – legislation that (1) targets financial institutions that “boycott” certain industries considered by the state in question to be important and (2) prohibits the use of state funds for the purpose of “social investment.”
Anti-ESG bills targeting financial institutions generally seek to prohibit state agencies from doing business with and/or investing state assets (commonly state pension plans) with financial institutions that are seen to discriminate by choosing not to invest in certain industries based on environmental or social concerns. These “Boycott Bills” most commonly relate to financial institutions with exclusionary investment policies targeting fossil-fuel producing energy companies, but also have been aimed at institutions seen to “boycott” state-relevant industries such as mining, firearms or production agriculture. These initiatives are often justified on the basis that they reduce support of financial institutions that indirectly harm the state’s citizens by refusing or limiting business with industries considered beneficial to the state economy.
In addition to the above, some Boycott Bills include provisions requiring entities that contract with the state to include specific representations or verifications in any contract (generally for a minimum contract value of $100,000) that the entity will not discriminate against any specific industry sought to be protected by applicable legislation.
The other category of potentially anti-ESG policies proposes banning the use of state funds for “social investment.” This approach often specifically bans the consideration of environmental or social factors in the investment of state funds, instead requiring the only purpose of investment be maximizing investment returns (i.e., profit and financial performance).
According to some ESG proponents, this anti-ESG legislation has the potential to cause widespread economic consequences. For example, in the context of oil and gas anti-ESG legislation, as one former US Treasury official noted, financial institutions banks may feel obligated to make potentially risky loans to energy companies for fear of the reprisal of state governments with strong anti-ESG legislation in place. As the former Treasury official noted, “[c]orners will be cut and, if examiners don’t notice, this can become a financial stability problem. It’s not just going to happen at one large bank; it could be the same dynamic with many of them.”
Recently, we have seen certain financial investors attack the “stakeholder capitalism” agenda often associated with the ESG movement with one outspoken entrepreneur and investor, urging certain public company CEOs to not make political statements on behalf of their respective companies, and to refrain from making hiring decisions based on race, sex, or political beliefs. Navigating the tensions here can be tricky and we are seeing some prominent US-based asset managers with a focus on ESG facing criticism from both sides of the ESG “debate” particularly around the issue of climate change and investments in the “fossil-fuel” sector.
A Quick Comparison with the UK
The above is very much in contrast with the current position in the UK. It is well-established that trustees of defined benefit pension schemes can consider ESG factors when making an investment decision where they are financially material. Whereas, if ESG factors are non-financial factors, then they can be considered if they do not result in financial detriment (i.e., essentially used as a tie-breaker).
Over the last few years, there has even been some movement to permit non-financial factors to be considered in an investment decision even where there is some element of financial detriment. The English Law Commission said that trustees may take account of non-financial factors: (i) if they have good reason to think that scheme members share a particular view; and (ii) their decision does not risk significant financial detriment to the fund (which implies that some financial detriment is acceptable).
It should be noted that the UK Association of Pension Lawyers does not agree with the Law Commission’s view. However, with industry pressure groups, the UK government and certain pension scheme members keen for UK defined benefit pension schemes to be instrumental in driving ESG, it seems likely that there will be further developments in this area. This is amplified by the Financial Times recently reporting that pensions of UK-based staff at FTSE 100 companies were linked to an estimated 131mn tonnes of carbon emissions through the investments made by their pension schemes – this could bring the impact that UK pension schemes can make on climate-related ESG factors into greater focus.
And what about Asia?
While anti-ESG sentiment may be building in the US, policymakers and legislators in many key jurisdictions across Asia continue to support the development of ESG frameworks and regulations. However, ESG policy developments in Asia are evolving in a flexible manner to address the varying needs of the region’s wide ranging economies. The ASEAN Taxonomy Board has acknowledged the unique differences across its member states and recognized that its economic and environmental context is different from Europe and the US. These differences are reflected in, for example, the green taxonomies being developed by ASEAN and countries in the region. In a previous blog post, we discussed the first ESG disclosure guidance from China which adapts ESG standards to fit the Chinese business landscape and the requirements of domestic laws and regulations. From a social perspective, Asian nations currently appear to prioritize diversity and inclusion rather than developing new regulations and guidelines on other social factors, such as human rights. While there remains a range of views expressed by Asia-based asset managers, there also does not appear to be any significant rebellion or challenge to this approach to ESG frameworks and regulations from asset owners in the region.