In US, the climate briefly turns on ESG

Politicians seldom debate market and investment policies. True, they question the influence the ruling dispensation has had on investment decisions — and have done so since the Hari Mundhra scandal in 1957, or when they smell blood, like with Harshad Mehta, Ketan Parekh, and Hindenburg, compelling regulators to review market mechanisms. Occasionally, they may debate something like the old pension scheme versus the new, but since this is mainly about pension benefits of retired government servants it really is not a real “debate”. But for the most, political parties steer clear of questions like whether we should shift to a T+2 or a T+1 settlement cycle or what constitutes a large-cap stock.

Given this, the current debate on ESG (“environment, social and governance”) in the US is noteworthy.

ESG is a framework that investors — $8 trillion by some reckoning — have adopted for making investment decisions. Looking beyond financial numbers, investors now measure E, or the impact resource use by a company has on the environment. S captures the social impact, usually employee-related themes like gender, health, and safety, and the role of the company as a Samaritan. G measures the board structures, processes, disclosures, and the transparency of companies. It is the outcome of co-opting the private sector in helping governments meet the Millennial Development Goals, which culminated in the adoption of the Sustainable Development Goals (SDGs) in 2015.

Extreme climate events and the philosophical shift from shareholder primacy to companies serving the interests of all stakeholders led to firms running green strategies and investors embracing those who did so by holding them in their portfolio. For the past many years, it has been one of the two defining trends of the asset management industry (the other being the shift to passive). Over the years, regulators have stepped up disclosures by companies and more recently funds on all things ESG. While most participants — companies, investors, auditors, regulators, consultants, advisors etc. — do not need to be preached to, a revolt is brewing along political lines in the US.

Using the pejorative “Woke-capitalism”, the backlash against ESG funds began in earnest when BlackRock and other large funds stopped investing in US energy companies, even as they took in pension money from employees in states whose local economy was dependent on these very companies. These are mainly Republican-controlled.

The stances hardened when in Florida, a Republican state, Disney took a stricter stance on preventing the spread of Covid-19 by mandating its workers and those visiting its theme parks to show proof of vaccination and wear a mask. The relations further soured when the state passed the Parental Rights in Education Act, prohibiting classroom instruction in sexual orientation and gender identity before the fourth grade (“teaching children that they can be whatever they want to be”). Executives at Disney protested, forcing the company to publicly criticise the law, leading to a showdown.

Mike Pence, former US vice-president, was scathing on ESG in his op-ed in the Wall Street Journal. He wrote: “ESG is a pernicious strategy, because it allows the left to accomplish what it could never hope to achieve at the ballot box or through competition in the free market. ESG empowers an unelected cabal of bureaucrats, regulators, and activist investors to rate companies based on their adherence to left-wing values.”

Last August, the attorney generals of 19 Republican states wrote to BlackRock, questioning ESG as an investment strategy while raising questions about the funds’ political affiliations. Many of these states are now enacting anti-ESG laws.

Meanwhile there is political ping-pong being played out in Washington. The Biden administration has eased rules that allow fiduciaries to factor in ESG criteria while investing, reversing the Trump administration’s regulation in 2020 that made it harder for funds to do so. On March 1, the Senate adopted a Republican-backed Bill overturning these new rules. President Joe Biden is expected to veto this Bill.

Even as this theatre is playing out, the US Securities and Exchange Commission has been pressing ahead with newer rules, standardising ESG disclosures by companies and funds. European regulators, unmindful of what is happening in the US, see no change in their stance. In India, the Securities and Exchange Board of India has signalled its intent that climate and stewardship remain high on its agenda by floating a discussion paper on ESG disclosures, ratings and investments and another on ESG rating providers.

The US is taking one step forward and two sideways. For all others, including for our markets, the shift to ESG is only accelerating.