Ask a Scientist: What’s Up With the Attack on ESG Investing?

October 12, 2022 | 3:15 pm
Dave Center/Flickr
Elliott Negin
Former Contributor

Officials at the state and federal level have launched a full-court press against what the financial industry calls “environmental, social and governance” (ESG) investing. They are especially squawking about investments that take into account the climate crisis, despite the fact that extreme weather events are wreaking havoc across the country.

Since the summer of 2021, five Republican-controlled state legislatures have passed bills banning their state governments from doing business with financial institutions that they allege have divested from fossil fuel companies as a result of ESG investment policies. Another six statehouses are considering similar bills. At last half of the bills are based on a template provided by the fossil fuel industry-funded American Legislative Exchange Council.

In May, former Vice President Mike Pence, writing in The Wall Street Journal, urged congressional Republicans to follow the states’ example by “end[ing] the use of ESG principles nationwide.” A month later, GOP lawmakers in Washington told E&E News that they will sponsor legislation that would do just that if they take over one or both chambers of Congress next year.

In August, The New York Times revealed that nearly two dozen Republican state treasurers, working with a relatively unknown nonprofit organization called the State Financial Officers Foundation, are collaborating to blunt climate action at the federal and state level, including withdrawing hundreds of millions of dollars in state investments from financial institutions they deem too preoccupied with environmental issues.

Not to be outdone, 19 Republican state attorneys general also joined the fray in August, falsely claiming that “woke” asset managers are politicizing their investments by adopting ESG criteria instead of focusing solely on financial returns, as required by law, at the expense of their state pension funds. (No surprise, the fossil fuel industry is a major sponsor of the Republican Attorneys General Association.)

A closer look at the facts shows that big banks and investment firms are still financing the fossil fuel industry to the tune of hundreds of billions of dollars a year. Indeed, a peer-reviewed study published in September linked nearly half of all global carbon emissions from the biggest energy companies to just 10 financial institutions, led by Vanguard and BlackRock, the world’s largest asset manager. One of the anti-ESG Republicans’ main targets, BlackRock has nearly $260 billion invested in fossil fuel companies around the world, including $91 billion in Texas, the first state to enact an anti-fossil fuel industry divestment law.

However, it is the case that it is more difficult for companies to obtain financing for oil and gas projects than renewable projects due to the mounting impacts of climate change. Lenders have been calculating those risks and factoring them into the cost of credit, leading to what a Goldman Sachs analyst called “an unprecedented shift in capital allocation.” Last year, she said, marked “the first time in history that renewable power [became] the largest area of energy investment.”

The larger question is: Are asset managers shirking their fiduciary duty to maximize returns by adopting ESG criteria, which generally favor renewables over fossil fuels? The short answer is no. Studies show that ESG investments actually result in comparable—or even better—returns than investments that only take into account financial factors.

For a deeper dive into this manufactured controversy, I contacted Laura Peterson, a corporate analyst with the Union of Concerned Scientists’ Climate Accountability Campaign. A former policy analyst for the Project on Government Oversight, Taxpayers for Common Sense, and the Senate Homeland Security and Governmental Affairs Committee, Peterson recently returned from an international conference on fossil fuel supply and climate policy at the University of Oxford in England, where she gave a talk on the backlash against efforts in the United States to require corporations to publicly disclose the projected impact climate change will have on their operations and assets. Below is an abridged version of our exchange.

EN: First, it would be helpful if you could explain how ESG investments differ from other sustainability investment strategies. Who coined the term, and how is ESG different than socially responsible investing or impact investing?

LP: A 2005 United Nations report, Who Cares Wins: Connecting Financial Markets to a Changing World, introduced the term and the acronym. The report found that incorporating ESG criteria into investments would not only benefit a company, but also potentially generate returns for investors.

ESG is often used interchangeably with the terms “socially responsible investing” (SRI) and “impact investing,” but there are important differences. ESG funds take into account a company’s environmental, social and governance practices, such as its climate policies or its executive compensation, but their primary goal is always to maximize financial returns. Socially responsible investing involves choosing or disqualifying investments based on specific ethical criteria. A good example would be screening out tobacco company stock. The goal of impact investing, meanwhile, is to help a business or organization support a specific social benefit, such as expanding women’s education or developing renewable energy resources.

Even proponents of ESG investing would agree that it is not being implemented perfectly. ESG disclosures vary from company to company. Ratings agencies that assess company data use proprietary methods, making it hard for investors to know how investment firms reach their conclusions. And there is growing concern that some asset managers are slapping ESG labels on funds that don’t deserve them.

That’s why the US Securities and Exchange Commission (SEC) proposed rules earlier this year that would tighten standards governing how investment firms and advisers market ESG funds, as well as require funds branded as ESG, SRI or other, similar terms to invest at least 80 percent of their assets in areas suggested by those terms. The proposed rules are intended to guard against greenwashing, when asset managers misrepresent financial products as ESG investments when the companies they are investing in don’t fit the criteria. The proposed rules resulted from a 2021 SEC risk alert that found inconsistent approaches to managing ESG-labeled funds as well as “inaccurate ESG-related disclosures and marketing materials.” Greenwashing can have serious consequences. The SEC recently fined BNY Mellon Investment Adviser $1.5 million for failing to review its investments under its ESG-marketed fund to ensure that they were, in fact, aligned with ESG criteria.

EN: How much money have asset managers put in ESG investments and how much are these investments expected to grow?

LP: Investor demand for ESG products has increased dramatically, and asset managers are listening. According to US SIF: The Forum for Sustainable and Responsible Investment, by January 2020, assets using sustainable investing strategies represented a third of all US assets under professional management. And that percentage will undoubtedly increase. Bloomberg Intelligence estimates global ESG assets are set to jump from $35 trillion today to $50 trillion in 2025.

The finance industry is particularly bullish on the E in ESG. More than 450 financial firms worldwide representing $130 trillion in assets have pledged to meet the 2015 Paris climate agreement goal of net-zero emissions by 2050. Goldman Sachs’ Carbonomics research estimates that $56 trillion of investments in clean tech infrastructure by 2050—$2 trillion annually—will be needed to reach that goal.

EN: In my introduction, I cited some of the political attacks on ESG investment policies, which rest on the false allegation that financial firms are boycotting fossil fuels. Ironically, pulling state money out of financial institutions that have adopted ESG policies could cost state taxpayers serious money.

LP: That’s right. A recent study by the Wharton School of Business and the US Federal Reserve found that Texas cities will pay an additional $303 million to $532 million in interest on $32 billion in borrowing during the first eight months after the Texas anti-fossil fuel industry divestment law was enacted.

EN: Not all state officials are on board the anti-ESG bandwagon. Last month, Democratic treasury officials from 13 states and New York City blasted politicians who have been promoting anti-ESG legislation. What can you tell us about this campaign?

The treasury officials founded a nonprofit organization called For the Long Term to encourage state financial officers to consider the long-term impacts of their investment decisions. “States that focus solely on the short term will fail to compete over the longer time horizon that is necessary for them and their pension funds to succeed,” the group’s website states. “In the case of state and public pension funds, these losses will be borne by the taxpayers and that means all of us.”

Last month, they published an open letter criticizing the attacks on ESG investing, stressing that climate change poses predictable economic risks to businesses as well as the general public. They turned the anti-ESG crowd’s argument on its head, pointing out that trying to punish asset managers that take climate change into account is in fact a political and ideological stance, not one based on pragmatic financial oversight. And it stands to hurt the taxpayers and pensioners whose interests anti-ESG officials are supposed to represent.

It’s important that these public financial officers spoke out, because the anti-ESG backlash has had a chilling effect on the modest progress financial institutions have made on addressing climate change.

Consider what has happened at BlackRock. In 2021, BlackRock CEO Larry Fink declared in a letter to the heads of the companies in which BlackRock invests that it is time to “confront the global threat of climate change more forcefully” and asked them to disclose publicly how their business model is “compatible with a net zero economy.” Many ESG advocates rightly pointed out at the time that BlackRock’s commitments were not specific or ambitious enough, but the letter sent an important signal given the firm’s influence in the investment community.

A year later, however, it was a different story. Likely in response to the concerted attack on ESG principles, BlackRock backpedaled during this year’s shareholder proxy season, claiming that climate-related shareholder resolutions were “more prescriptive … and may not promote long-term shareholder value.” And when Texas moved to withdraw state pension funds from financial institutions the state perceives to be unfriendly to oil and gas, BlackRock posted a letter touting its investments in fossil fuel companies.

For the Long Term took notice. Last month, one of the organization’s founders, New York City Comptroller Brad Lander, sent a strongly worded letter to Larry Fink to register his “growing concern that BlackRock is backtracking on its climate commitments” and warning that the city will reassess its relationship with BlackRock if its investment decisions do not match its “stated commitment to net zero emissions.”

Given that New York City has the country’s fourth largest public pension plan with some $250 billion in assets under management, BlackRock and other major investment firms have to understand that there will be consequences for not addressing the risks and harms of fossil fuel-driven climate change.

In fact, the 14 members of For the Long Term are merely doing their jobs. They have a duty to manage their state and city investments prudently. Given the overwhelming scientific consensus that the climate crisis is happening right now and that there is a rapidly closing window to avert catastrophic damages, it is simply irresponsible not to take this reality into account when making investment decisions.

EN: The US Securities and Exchange Commission has proposed a rule that would mandate and standardize climate disclosures by publicly traded companies, which the State Financial Officers Foundation and Republican attorneys general predictably oppose. What is the status of that rule, and what impact would it have?

LP: The SEC proposed a draft rule in March that would compel publicly traded companies to assess and report on how climate change will affect their bottom lines and, by extension, investors and the general public.

Among its provisions, the rule would require companies to disclose the amount of global warming emissions their businesses produce, estimate how commodity price changes might affect their profits, and detail their plans for implementing carbon emissions reduction targets. To date, the commission has received more than 15,000 comments showing broad support. Ninety percent of the 10,000 form letters it has received back the rule, and an analysis of more than 4,000 individual comments found strong investor community support.

The fossil fuel industry, its trade associations, and the think tanks and advocacy groups it funds oppose various provisions of the proposed rule, claiming that they fall outside the commission’s mandate and impose what they consider burdensome reporting requirements, especially when it comes to Scope 3 global warming emissions—emissions that result from the use of a company’s products, such as gasoline—as opposed to direct emissions from a company’s operations, called Scope 1, or emissions from the electricity it uses, called Scope 2.

Echoing the fossil fuel industry, West Virginia Attorney General Patrick Morrisey and 20 other Republican state attorneys general filed a comment with the SEC in August opposing the rule, charging that it “exceeds the agency’s authority, violates the First Amendment, and is arbitrary and capricious.” The SEC has not announced when it will issue a final rule, but Morrisey and his fellow attorneys general have pledged to file suit against the SEC to kill it.

The Union of Concerned Scientists (UCS) supports the rule, and we have called for the SEC to strengthen it in several ways, including by requiring companies to publicly disclose their direct and indirect political activity and how they are addressing climate justice. UCS has joined with investors and other advocates to urge the SEC to finalize and enforce a strong rule as soon as possible. As the climate crisis worsens, there is no time to waste.