The Politics of ESG Investing

Florida Gov. Ron DeSantis made headlines when he banned the state’s pension system in August 2022 from making investment decisions based on environmental, social, and corporate governance guidelines or any other guidelines outside of pure financial performance. 

This is one of several recent examples of Republican officials in red states making such decisions when it comes to using ESG or other social responsibility factors in policymaking or administrative decisions. 

Around the same time DeSantis announced his decision, Texas banned 10 banks and 348 investment funds from doing business with the state for allegedly boycotting fossil-fuel based energy companies. And before that, Utah threatened to sue S&P over its use of ESG as part of its creditworthiness rating criteria for the state.

While the initial reaction is that these states are engaging in political grandstanding, when you take a deeper look, you begin to see that there is some substance to these positions. 

Investors use ESG to assess environmental and social risks. It can also be used by asset owners and fiduciaries (i.e. pension beneficiaries) as a way to establish metrics to determine if their state-managed investments could cause future financial harm to the state in any way. However, as Route Fifty noted in a piece earlier this year, the demand for using ESG in investment decision-making is driven primarily by the institutional investor community. And in Republican-led states, it’s clear they want to retain the status quo for investment decisions and use quantifiable financial value as the basis for their investments. 

Taking that into consideration you start to see why leaders in Florida, Texas and Utah have come out against it.    

Let’s look at Florida. DeSantis is the chairman of the State Board of Administration. Under Florida law, he has a fiduciary responsibility to manage the assets of the state’s retirement trust on behalf of those who contribute to it and ensure that they receive the maximum return. In other words, if pension holders believe that only financial value should be considered as the criteria to which they invest, then the governor is acting accordingly under their guidance. 

In Utah, the state contends that its history of creditworthiness is a matter of fact. Whereas the potential financial impact of social and environmental risks is subjective. This subjectivity could cost the taxpayers of Utah millions in additional debt service costs. 

Similarly, in Texas, economic output is tied to oil and gas extraction. If the state is constricted by banking policies that limit investment in the oil and gas industries, it would jeopardize future economic activity to support jobs and tax revenue needs.

When you consider the realities of the current economic status of these states, you can see that ESG criteria could have serious short-term negative financial outcomes that could create down pressure on jobs, revenue and state services. 

Despite these concerns, what these states need to understand is that the implementation of ESG, which is driven by the need for social responsibility along with risk management along environmentally and socially related risks, is fluid in nature. State officials need to be able to balance multiple priorities, including short and long-term impact, economic growth, environmental impact, social risks and adaptation to climate change. 

Currently, that balance is missing in these discussions. Similarly, what’s missing is consensus on the materiality of how environmental and social risks, particularly climate change and its related risks, which ESG is dedicated to quantifying, will impact assets in the pension fund?      

For example, the debate in Florida over fiduciary responsibility and whether the State Board of Administration should consider ESG-related criteria has merits on both sides. All residents of the state deserve to have maximum financial returns from investments made by pension assets, but an elongated view shows that environmental and social risks could threaten long-term performance. 

In Texas, an absolutist view from banks and investment funds results in a negative impact on the oil and gas industry but aligns to a view that stripping investment in extractive industries limits the effects of climate change in the long run. However, is there an approach to take multiple factors into consideration, including commitments to ensure projects limit their environmental impacts to a certain threshold?

This is why it’s important to separate the politics from the policy so as not to limit an optimal solution. ESG is a way to quantify environmental and social-related risks. It allows the incorporation of these risk metrics into data-based, objective decision-making, so if used properly, it could weigh the costs and benefits of extractive-based energy production. But politics might skew reality and pull us away from such an optimal place.