MARK FELIX/AFP via Getty Images
A growing number of Republican politicians tend to penalize Wall Street investors who consider environmental, social and governance (ESG) issues when deciding where to put clients’ money.
In Florida, a state board chaired by Governor Ron DeSantis recently prohibited investment fund managers and advisers from considering “social, political, or ideological interests” when making decisions about the Florida’s retirement system. In Texas and West Virginia, GOP leaders say they will block investors from state-owned companies they say are “boycotting” the fossil fuel industry. Fifteen other states are considering similar measures. And Republicans have said that if they resume Congress midterm, they plan to push federal legislation to restrict investment decisions they attack as “woke.”
Anti-ESG Republicans say big financial corporations are abusing their power to advance a liberal agenda on issues like diversity, social justice and, in particular, climate change.
Many experts disagree, saying Republicans are misrepresenting ESG investment goals and strategies.
It’s hard for most people to get a clear reading of what ESG is amid the overheated rhetoric. Is the idea to bring about social changes that could not be achieved through the ballot box? And what does that mean for things like your 401K when investors follow ESG principles?
This FAQ is for anyone who wants to better understand an investment trend that is becoming central to global financial markets and a new frontier in American politics – including, possibly, in your own state.
What is ESG?
It’s probably easiest to think of this as a set of considerations that investors use to try to understand risks and opportunities that aren’t factored into traditional financial models.
Climate change is one of the simplest examples: investors are trying to find out how the physical risks associated with factors such as sea level rise and worsening drought could impact business operations. For example, does a company depend on water to run its factories or to transport goods to places like Europe or China where the rivers have dried up this summer?
Investors also want information on “transition risk” – how companies will fare as governments adopt policies to cut emissions and demand increases for things like renewables and batteries.
“It’s about looking at a company and saying, ‘Are they ready for the climate transition that’s coming?'” says Witold Henisz, director of the ESG Initiative at the Wharton School of Business. University of Pennsylvania. “Some companies are, and some aren’t. And it tilts your portfolio, it changes your investment strategy.”
ESG is different from impact investing, where the goal is to make money by investing in companies that attempt to achieve certain social or environmental outcomes.
“In our view, ESG is more of a kind of defensive framework,” says Kunal Shah, managing director of iCapital, a fintech company. “While impact investing…focuses on investing in companies with a clear mission to bring about positive change.”
Justin Sullivan/Getty Images
Are ESG investors boycotting fossil fuels?
It doesn’t look like that. The big banks continue to provide hundreds of billions of dollars in financing to the fossil fuel industry each year. BlackRock, the world’s largest asset manager and a favorite target of anti-ESG Republicans, is a major shareholder in many major oil and gas companies.
“ESG is not about boycotting,” says Henisz of the Wharton School. “It’s a question of which fossil fuel company do you own? And how long do you own them?”
In fact, BlackRock CEO Larry Fink has said he thinks selling off fossil fuel stocks — or divestment — is an ineffective way to tackle climate change. Instead, Fink argued for engagement, urging shareholders to pressure fossil fuel executives to be transparent about their plans for the future.
That said, it has become more expensive for fossil fuel companies to borrow money in recent years, reflecting the risks these companies face due to climate change, says Tensie Whelan, director of the Stern Center for Sustainable Business from New York University.
“It’s not so much [lenders are] punish companies. They just say, ‘Hey, there’s a risk. And like we would with any other product, we need to financially assess those risks and factor them into the cost of credit,” Whalen says.
Does ESG harm the financial performance of companies or investors?
This does not seem to be the case.
NYU’s Whalen co-authored a report examining the relationship between ESG and financial performance. After reviewing more than 1,000 research papers published between 2015 and 2020, Whalen’s team found that companies’ sustainability initiatives often seemed to drive better financial performance. They also found that in many cases, the use of ESG investment strategies appeared to produce similar or better financial results compared to conventional approaches.
That doesn’t mean that proponents of ESG investing think it’s done perfectly. ESG information varies from company to company. The ratings agencies that assess the data use proprietary methods, making it difficult for investors to know how the companies reach their conclusions. And there are growing fears that some asset managers are applying ESG labels to funds that don’t deserve them.
“The problem is that we don’t have good data,” says Henisz of the Wharton School. “And so we struggle to measure whether companies are delivering.”
ROBYN BECK/AFP via Getty Images
Why is ESG becoming a political fight now?
Observers point to two potential factors, which are not mutually exclusive.
One is that ESG — and climate considerations more broadly — are entrenched enough in U.S. businesses and financial markets to start changing the way some industries operate, says Mindy Lubber, CEO of nonprofit Ceres. sustainable development non-profit.
Hundreds of companies and investment firms, for example, have now pledged to eliminate or offset their greenhouse gas emissions. Only a few years ago there were practically none.
The other explanation is that the Republicans are trying to score political points before the election.
“Taking climate risk as an investment risk is just good business,” says Henisz of the Wharton School. “Now we can discuss how we do it and who does it well and who does it badly. That’s a legitimate argument. [But] the idea that ESG is ideological and not economic is a political argument.”