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Environmental, social and corporate governance, ESG, has taken off in recent years. And in the process, it has broadened the ideological divide between liberal-leaning states and conservative ones, with lawmakers in the former embracing ESG principles and those in the latter rejecting such ideas. The politicization of the issue has placed companies targeted by the ESG legislation in a difficult position and complicated the job of government affairs and compliance professionals tasked with staying on top of ESG-related developments.
The rise of ESG in the United States was driven by investor demand, according to Leah Malone and Emily B. Holland, attorneys with Simpson Thacher & Bartlett LLP’s Environmental, Social and Governance (ESG) and Sustainability Practice. As investment dollars started flowing into ESG-oriented funds, companies came under pressure to be more transparent about their efforts to address issues like climate change, environmental sustainability, human rights, diversity and executive compensation.
In recent years a number of states have introduced or enacted legislation promoting the consideration of ESG factors in investment decisions regarding state funds, prohibiting investment in ESG-unfriendly industries like fossil fuel production and firearms manufacturing, or requiring corporations to disclose information about their greenhouse gas emissions.
But there has also been significant pushback against ESG policies, with many states having introduced or enacted measures prohibiting the consideration of ESG factors in public investment decisions or restricting state entities from doing business with companies that boycott fossil fuel or firearm companies.
The pro-ESG, anti-ESG divide has fallen largely along party lines. Last year Capital Monitor mapped the 31 states that considered ESG-related measures in 2022 in relation to how those states voted in the 2020 presidential election. All 17 of the states that voted Republican proposed anti-ESG bills, while 11 of the 14 that voted Democratic introduced pro-ESG measures.
“The rapid growth in anti-ESG policies since the start of 2022 alone leaves little room for doubt: ESG investing is a clear target of the ongoing culture wars in the U.S., joining critical race theory, trans rights and Covid masks,” the publication concluded.
Dave Wallack, executive director of For the Long Term, a group that advocates for ESG policies, told Capital Monitor the fact that deep blue states like New York and Washington hadn’t introduced pro-ESG laws didn’t mean fiduciaries in the states weren’t obliged to take ESG risks into account. (Both New York and Washington have introduced pro-ESG measures in 2023.)
“For many, debating whether climate change is a financial risk is like debating gravity—climate change is self-evidently a material risk over the long term. There’s a lot of evidence for that,” he said. “So I would say actively avoiding passing an anti-ESG law is basically an affirmative statement, because you don’t need a pro-ESG law to use ESG principles. ESG investing is a third of the market.”
Capital Monitor also pointed out that every red state hadn’t introduced anti-ESG legislation either.
“I view this as governors thinking about their presidential ambitions more than the welfare of their pension funds,” the head of sustainable finance for a major bank told the publication. “The idea of not taking ESG factors into account is just silly—everybody has considered those risks forever. It’s just a great way of pointing the finger at the other guys and saying ‘they’re trying to hurt you. Vote for me’.”
Whatever its motivation, the flood of ESG legislation has continued this year—and the partisan divide along with it. So far at least 35 states have considered ESG-related measures, according to Malone’s and Holland’s March analysis, as well as a more recent accounting using the LexisNexis® State Net® legislative database.
Twenty-five states have considered and eight have enacted anti-ESG measures, which fall mainly into three categories:
Texas, meanwhile, is considering legislation (HB 1239/SB 833) that would prohibit insurers from using ESG criteria to set rates.
Ten states have considered pro-ESG legislation, none of which has been enacted. Again, the measures fall into three main categories:
Additionally, Massachusetts has introduced what could be described as anti-anti-ESG legislation (HB 2434 and SB 1648). It would prohibit investment of public money with a financial services company headquartered in or managed by individuals who reside in a state that has prohibited ESG investing.
So far this year at least 35 states have considered legislation related to environmental, social and governance, or ESG, according to analysis by Leah Malone and Emily B. Holland, attorneys with Simpson Thacher & Bartlett LLP’s Environmental, Social and Governance (ESG) and Sustainability Practice, and State Net®. The majority of those measures—introduced mainly in states that voted Republican in the 2020 presidential race—are aimed at restricting the use of ESG policies in state investing and contracting. A smaller number of measures—introduced mainly in states that voted Democratic in 2020—are aimed at promoting the use of ESG policies.
The current political climate has forced investment companies to perform a delicate balancing act to avoid alienating either the pro- or anti-ESG camps. Last year, after coming under fire from Texas lawmakers for boycotting energy companies, Blackrock publicly touted its support of the fossil fuel industry and its support of efforts to address climate change.
Capital Monitor reported that some asset managers have become reluctant to discuss their ESG efforts publicly out of fear of being targeted by one side or the other.
“A blacklist doesn’t only impact the behaviour of the people that are blacklisted—everyone starts worrying about it,” Wallack told the publication.
In addition to the potential financial hit companies face from being blacklisted, they can also be subject to hefty penalties for failing to comply with some ESG measures. A bill under consideration in Missouri (SB 436), for example, would make investment fiduciaries that violate its provisions subject to a fine equal to three times the total amount the state paid them for their services.
ESG legislation also poses challenges for the government affairs and compliance professionals responsible for keeping track of it. Malone and Holland note that in addition to the sheer volume of measures, they vary in scope and speed through the legislative process. In addition, they include “carve-outs” and “vaguely defined” terms that raise questions about their applicability.
The attorneys also say the more extreme legislation is subject to change or failure in the face of “powerful opposition constituencies reacting to real or perceived increases to the cost of capital, or to compliance-related challenges.” For instance, Indiana HB 1008 was amended to make private market funds exempt from its anti-ESG investing provisions after drawing opposition from the state’s Chamber of Commerce.
Investment companies and government affairs and compliance professionals may have to continue dealing with such challenges for a while, according to Malone and Holland.
“We expect more states to propose or adopt anti- (and pro-) ESG state laws, particularly as the 2024 U.S. presidential election approaches and political agendas solidify, and as the global ESG regulatory framework, including a growing web of EU-related ESG measures, comes into greater focus,” they said.
They also advised: “Given the vast number and intricacy of these state measures, and the rapidity with which they are being introduced and implemented, companies are wise to monitor developments in this space closely, and to assess what steps may be prudent, given potential impacts associated with such measures.”
—By SNCJ Managing Editor KOREY CLARK
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