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Attacks on ESG May Have Unintended Effects

As a quick Google search can attest, ESG investing is under attack. While much of the public criticism has taken the form of political posturing, other actions have been more material. In Congress, a planned resolution seeks to roll back new Department of Labor (DOL) rules allowing retirement plan fiduciaries to consider environmental and social factors, including climate change, when making investments. (This rule, in turn, is widely viewed as a response to Trump-era DOL rules explicitly forbidding the consideration of factors that are not “pecuniary” in managing retirement plan investments.)

At the SEC, new climate disclosure rules for companies may reportedly be scaled back in their final form. Pushback from companies and lawmakers has been particularly intense over proposed requirements for larger companies to report Scope 3 emissions (those in their supply chains, or produced by their products). In part because of threatened lawsuits, these Scope 3 disclosures—which are viewed by many as critical to fighting climate change—could face an uncertain future.

At the state level, the massive investment firm Blackrock has become a popular target. Based on the company’s commitment to supporting a net-zero transition, states including Florida, Louisiana, Arizona, Missouri, South Carolina, Arkansas, Utah and West Virginia have divested treasury or pension funds from BlackRock. Legislation in Texas, Oklahoma and Kentucky suggests those states will follow suit.

Our reaction to these attacks is twofold. First, the suggestion that “externalities” such as climate change should not be prioritized by investors is one we view as, at best, dangerously short-sighted. Climate change is, in fact, expected to heavily impact corporate performance, as repeated analyses continually demonstrate. The radical long-term investment strategy would be to ignore this reality, not to ask companies to plan for it. The DOL and and SEC rules simply recognize this. We are grateful that the President’s veto power should largely protect the DOL rule, and we are optimistic that Scope 3 provisions will remain in the final version of the SEC’s climate disclosure rules as well.

Second, we believe the attacks reveal an important duality in the ESG movement. In his 2020 letter to CEOs, Blackrock’s own Chair and CEO, Larry Fink, wrote compellingly about the urgency of climate change for investors. But in Blackrock’s 2022 letter responding to the attorneys general of states threatening divestment, the company pointed out that “BlackRock, on behalf of our clients, is among the largest investors in public energy companies, and has hundreds of billions of dollars invested in these companies globally, with approximately $170 billion invested in US companies.”

To some in the professional investor class, Fink’s professed commitment to both address climate change and invest profitably in today’s energy sector may sound like good strategy. But we believe it highlights ESG’s persistent weakness: a lack of standardized principles or regulation, which makes ESG both an easy target for its enemies and a more confusing one for aspiring investors.

In fact, the term “ESG,” coined in 2004, was never intended to refer to specific industries or practices. Instead, it was an attempt to broaden the definition of financial risk to include environmental and social factors. While this means ESG frequently aligns with our own investment strategy (which we now refer to as “Sustainable Investing,” or traditionally, “Socially Responsible Investing”), that is not always the case. For instance, widely used ESG rating systems frequently give “A” grades to fossil fuel companies. We do not invest in fossil fuel companies.

Why is the ESG label applied to such a diverse array of investment approaches? In part, we believe, because massive investment firms that are aggressively marketing their ESG credentials have, at least until now, welcomed the perception that ESG is a form of activism on issues like climate change or racial justice. But as Fink’s response to the Blackrock divestment movement makes clear, that is simply not the reality.

With better regulation, we believe ESG can be an important step forward in broadening the definition of corporate value and corporate impact. But as widely practiced today, ESG is not the same thing as excluding harmful industries from investment consideration. It is not the same thing as researching and prioritizing companies that show demonstrable progress in lowering emissions or improving gender and racial pay equity. It is not the same thing as voting out entrenched board directors who lack diversity of background or experience. And it is not the same thing as filing shareholder proposals when corporate engagement over critical environmental and social issues does not produce results.

Some have suggested that attacks on ESG may backfire, in the form of lawsuits against states that rush into irresponsible divestment. But we believe a more important silver lining will be increased rigor in defining ESG. In particular, focusing public attention on the claims and limits of ESG investing could result in better delineation between the ways investment strategies are attentive to environmental and social risk. Separating ESG from sustainable investing, for instance, would not only help undercut the current attacks; it could also out “greenwashing” and equivocation by companies who want to have it both ways. This, in turn, will create clearer pathways for investors who want to move from traditional strategies into those that prioritize environmental and social factors. And that can make the world a better place.