Red and Blue States Take Sides in Federal ESG Fight

The environmental, social and governance (ESG) movement has become one of the most divisive issues among state legislators in 2023. ESG refers to a set of nonfinancial standards for a company’s behavior used by socially conscious investors; ESG investment funds may stop investing or decline to invest in companies that don’t comply with these standards. Generally, Democrats tend to favor ESG because it aligns with policy goals they favor, such as environmentalism and support for marginalized communities. Republicans, to the contrary, tend to dislike ESG, for both political and economic reasons: Should investment managers be making decisions based on factors other than wealth maximization for their clients?

ESG has gained traction among many investment firms and within the federal government, but it is seeing a divided response in the states. Many red states have adopted measures that punish private companies and asset managers for discriminating against non-ESG investment funds. Some states have gone so far as to deny business to certain asset managers who prioritize ESG factors when investing.

By contrast, a number of blue states have adopted measures that encourage private businesses to pursue ESG considerations in their financial decisions. Some of these policies reflect pro-ESG regulations emerging across executive branch departments and independent agencies at the federal level. As evident from state-level trends, the subject of ESG is sharply polarizing, financially impactful and increasingly salient to members of both parties.

ESG in the Real World

ESG policy implications can be grouped into three broad areas: exclusion, integration and risk assessment. Exclusionary ESG ensures that certain industries—for example, tobacco or firearms—are excluded from consideration in an investment portfolio. This tactic is used most frequently by ESG-conscious asset managers and registered investment advisers entrusted with directing people’s financial engagement in secondary markets (such as the New York Stock Exchange and the Nasdaq).

Proponents of exclusionary ESG use “ESG screening,” a judgement-based method for singling out a set of practices, professional sectors and fund types deemed to be undesirable investment vehicles. A number of asset firms have also used ESG screening to exclude industries that violate a public company’s internal sustainability goals or practices. For example, BlackRock CEO Larry Fink pledged to divest from thermal coal producers, a policy set forth in a controversial 2020 letter, “A Fundamental Reshaping of Finance.”

At the same time, Fink phased in a new ESG-centered framework for BlackRock by prioritizing sustainable stewardship over capital returns, simultaneously “launching new investment products that screen [out] fossil fuels.” This method of phasing in a sustainable investing approach is the second method of ESG, called ESG integration. Under ESG integration, investment managers use institutional investors to finance various ESG objectives. Where exclusionary ESG screening excludes practices and industries that are deemed to be antithetical to an environmentally conscious investor or a social justice activist, ESG integration targets investment vehicles that cater to these customers. ESG funds are generally assembled with the expectation of pursuing a set of nonfinancial goals, often divorced from profit maximization.

Read the full article on Discourse Magazine.