Economy and Society: November 29, 2022
ESG Developments This Week
In Washington, D.C.
Department of Labor issues final rule on ESG and ERISA
For most of the Biden presidency, the Department of Labor has been working on a final rule addressing the use of ESG in Employee Retirement Income Security Act (ERISA)-governed retirement plans. That final rule was released November 22. According to the Wall Street Journal:
“More retirement savers could soon have the option to invest in funds based on environmental, social and governance principles, under final regulations issued by the Labor Department on Tuesday.
The new rule reverses a move by the Trump administration in 2020 that made it harder for 401(k) plans to put ESG investments on the menu. That regulation went into effect shortly before President Biden took office, but the administration moved to replace it.
“Today’s rule clarifies that retirement plan fiduciaries can take into account the potential financial benefits of investing in companies committed to positive environmental, social and governance actions,” when selecting 401(k) investments and exercising proxy voting, Labor Secretary Marty Walsh said….
Relatively few 401(k) plans offer ESG investments, in part because of regulatory changes from one administration to the next.
Lisa Gomez, assistant secretary for the Labor Department’s Employee Benefits Security Administration, said regulators heard from 401(k) plan sponsors and others in the retirement industry that the Trump-era regulation “had a chilling effect on being able to consider climate change and other ESG factors in making decisions” about investment offerings.
The new rule allows employers to consider climate change and other environmental, social and governance effects when selecting 401(k) investments and exercising shareholder rights, such as proxy voting, she said. Employers must put the financial interests of employees first and cannot sacrifice potential returns for these goals, she added.
Currently, 13% of 401(k) plans offer socially responsible investment options to employees, according to data that Vanguard Group publishes on the 401(k) plans it administers.
Demand for such investments in 401(k) plans is likely to grow, especially from younger workers, industry observers said….
The Biden administration rule will go into effect 60 days after its publication in the Federal Register, which should happen soon, said Ms. Gomez.”
SEC fines Goldman Sachs over ESG branding
Early in the Biden presidency, the Securities and Exchange Commission (SEC) launched an effort to scrutinize more thoroughly the ESG claims of investment managers. On November 22, the agency fined Goldman Sachs $4 million for branding products as ESG-friendly while failing to, in the SEC’s view, maintain sufficient ESG research and maintenance policies:
“The Securities and Exchange Commission today charged Goldman Sachs Asset Management, L.P. (GSAM) for policies and procedures failures involving two mutual funds and one separately managed account strategy marketed as Environmental, Social, and Governance (ESG) investments. To settle the charges, GSAM agreed to pay a $4 million penalty.
The SEC’s order finds that, from April 2017 until February 2020, GSAM had several policies and procedures failures involving the ESG research its investment teams used to select and monitor securities. From April 2017 until June 2018, the company failed to have any written policies and procedures for ESG research in one product, and once policies and procedures were established, it failed to follow them consistently prior to February 2020. For example, the order finds that GSAM’s policies and procedures required its personnel to complete a questionnaire for every company it planned to include in each product’s investment portfolio prior to the selection; however, personnel completed many of the ESG questionnaires after securities were already selected for inclusion and relied on previous ESG research, which was often conducted in a different manner than what was required in its policies and procedures. GSAM shared information about its policies and procedures, which it failed to follow consistently, with third parties, including intermediaries and the funds’ board of trustees.
“In response to investor demand, advisers like Goldman Sachs Asset Management are increasingly branding and marketing their funds and strategies as ‘ESG,’” said Sanjay Wadhwa, Deputy Director of the SEC’s Division of Enforcement and head of its Climate and ESG Task Force. “When they do, they must establish reasonable policies and procedures governing how the ESG factors will be evaluated as part of the investment process, and then follow those policies and procedures, to avoid providing investors with information about these products that differs from their practices.”
“Today’s action reinforces that investment advisers must develop and adhere to their policies and procedures over their investment processes, including ESG research, to ensure investors receive the advisory services they would expect to receive from an ESG investment,” said Andrew Dean, Co-Chief of the Enforcement Division’s Asset Management Unit.
GSAM consented to the entry of the SEC’s order finding that it violated Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7. Without admitting or denying the SEC’s findings, GSAM agreed to a cease-and-desist order, a censure, and a $4 million penalty.”
In the states
West Virginia State Treasurer Riley Moore announces run for Congress
West Virginia State Treasurer Riley Moore (R) announced last week that he is running for Congress in 2024 to represent West Virginia’s Second Congressional District. Moore has been among the leaders in the state-level pushback against ESG investing. He made headlines earlier this year when he told asset management companies that they would no longer be eligible to do business with the state if their investment policies were perceived as harmful to its economy. Moore said he would use his experience as treasurer to craft legislation opposing ESG if he is elected:
“West Virginia Treasurer Riley Moore has made battling ESG a top priority, and he now hopes to bring that fight to the halls of Congress.
Moore jumped into the 2024 contest this week, seeking the Republican nomination to represent the state’s 2nd District. Moore grabbed national headlines by using the power of the typically low-profile state treasurer role to work against the environmental, social, and governance push from corporations and financial institutions.
Moore told the Washington Examiner during a Tuesday interview that he hopes to continue his anti-ESG crusade at the federal level should he be chosen to serve in Congress.
“Look, I’ve been in the trenches on this for two years, and by the time I get there, it will be four years in dealing with it on a day-to-day basis,” Moore said about ESG. “So I’m going to have a wealth of experience coming into Congress, if I’m so lucky to be elected, that can help and inform this ESG scheme that we’re trying to defeat.”
While proponents of ESG see it as a way that finance and business can effect social change, such as by mitigating the effects of climate change, Moore and Republicans see the push as an attempt to distort the free market and even the culture of the United States through capital and influence.
“Certainly there have been individuals and elected officials on the Hill that have talked about ESG, but I think there is not a total comprehensive understanding of how pervasive this is, how dangerous it is, and steps that need to be taken to kind of fill in some of the cracks here where the states obviously cannot,” he said.
Moore has taken several actions against ESG over the past couple of years, with many other GOP state treasurers following suit.
“I was the first state treasurer in the country to divest from BlackRock, the first state treasurer in the country to put out a restricted financial institution list,” Moore said.
Earlier this year, Moore announced that his state would end the use of a BlackRock investment fund. He said BlackRock has pushed companies to embrace investment strategies that hurt the fossil fuel industry while increasing investment in Chinese companies that go against U.S. interests and damage his state's manufacturing base.
Over the summer, his office also declared five financial institutions ineligible for state banking contracts on the grounds that they “boycott” fossil fuel companies.
The restricted financial institutions are BlackRock, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo — many of the biggest financial firms in the world. As the blacklist took effect, all five firms are no longer eligible for state contracts, and any existing contracts were voided. The news meant the firms will lose access to $18 billion in annual inflows and outflows.
Moore said the topic of ESG has generated a tremendous amount of attention among constituents in the state….
Moore said if elected to serve in Congress, he wants to look at the rating agencies given that some now have ESG considerations in the bond ratings — something he referred to as “economic extortion.”
Additionally, Moore said he hopes to push for aggressive oversight in the ESG realm more generally should be elected to serve the 2nd District.”
Idaho legislature prepares bills to prohibit ESG investing with public money
Republicans in Idaho’s legislature are preparing to join a growing group of state-level elected officials seeking to insulate their states against ESG, according to the Idaho Capital Sun:
“Idaho Republican legislators and state officials are preparing bills for the upcoming 2023 legislative session that would be designed to further restrict using environmental, social and governance standards in public funding or investments.
The Idaho Legislature’s Joint Interim Committee on Federalism discussed legislation to limit or block environmental, social and governance, or ESG, standards during a meeting Monday at the Idaho State Capitol in Boise. The meeting was likely the final legislative meeting before a new crop of 39 first-time legislators are sworn in next week during the organizational session for the 2023 legislative session.
During Monday’s Committee on Federalism meeting, Rep. Baraba Ehardt, R-Idaho Falls, described meeting with U.S. Sen. Mike Crapo, R-Idaho, Idaho State Treasurer Julie Ellsworth, state Rep. Sage Dixon, R-Ponderay, and state Sens. C. Scott Grow, R-Eagle, and Doug Ricks, R-Rexburg, while drafting a bill.
Ehardt also said she has traveled to conferences to work on the bill. Members of the Committee on Federalism had previously met with the director of the Free Enterprise Project and a chief economist with the American Legislative Exchange Council about ESG in June….
Ehardt and Ellsworth said they are not looking to stop private businesses from investing the way they want to.
“Any legislation that I am working on deals with public monies,” Ellsworth told the committee. “This is an important concept and a very important distinction. This is not about the private sector. It’s about public monies. If you are going to be a credit union or bank that is seeking to do business with the state of Idaho … you cannot override for ESG purposes and boycott legal operating businesses in our state and still qualify as a depository for the state of Idaho.”
Ehardt and Ellsworth said their legislation is not yet in final draft form, and they did not share copies of their bill.”
In the spotlight
NYU business professor argues against ESG
Timothy M. Doyle, a senior advisor at the Bipartisan Policy Center, recently interviewed Aswath Damodaran, professor of corporate finance and valuation at the NYU Stern School of Business and “one of the foremost academic critics of ESG.” Highlights of the conversation include the following:
“While advocates sell the concept that ESG objectives are “good for everyone,” Damodaran points out that few stop to acknowledge that “ESG may be good for some companies, may be neutral for others, but will end up hurting the value of others with lower earnings and increased costs because that’s what ESG would require.” In other words, certain ESG-related risk factors may not be material for all companies. “To save ESG, we need to start telling the truth, that ESG is not good for all companies,” he says.
Professor Damodaran argues that ESG’s meteoric rise is attributable to good timing: it focused on lower carbon footprints, which led to weighted investments in technology companies that were overperforming the market and less investments in energy companies that were underperforming. The tables have recently turned, however, and ESG is not showing its promised performance. As a result, ESG advocates are now expanding or redefining ESG to include companies that had previously been excluded, such as energy firms and weapons manufacturers. Unfortunately, the inclusion of non-traditional ESG companies is a break from ESG’s foundational principles. “Whatever intellectual consistency there was in the concept is now completely gone,” Damodaran notes.
Damodaran has no issue with any of the three main types of ESG investing: strategic/active; exclusionary/inclusionary; and impact investing, provided that the investor is informed that ESG is a constraint and will almost certainly result in lower returns over the long term. In addition, for impact investing, he argues that investors must understand the probability of questionable impacts, and that any desired impact is “measured all the way through” to its intended purpose. For example, if a publicly traded company is pressured to refrain from producing a profitable product or service, in all likelihood those products or services will be absorbed by another company, by a private equity firm, or – when it comes to energy production – by a state-owned enterprise. Unfortunately, many times the impact sought can actually be worse because some of those other entities involve “some of the least scrupulous people on the face of the earth.” He argues that the “impacts” most commonly cited typically affect only U.S. and European publicly traded companies embracing ESG, and that the global impact is therefore de minimis. In conclusion, he argues and has previously written that impact investing ends up “sounding good” but not actually “doing good” and, in some cases, causes increased harm.
My biggest question was saved until last: Who should decide what constitutes “good?” Damodaran argues the rise of ESG has removed that decision from investors and centralized it with asset managers and more recently with CEOs. The subjectivity of what constitutes “goodness” is the fatal flaw of the current form of ESG.”
