End of Week Notes
What the Red Trickle means for ESG
Why the anti-ESG campaign won’t work
The massive Red Wave that threatened to swamp Democrats in the midterm elections turned out to be a trickle made possible by gerrymandering.
If I may put my political science cap on for a moment, it never stood to reason that this would be a typical midterm because we are not living in normal times. We’ve never had an ongoing threat to democracy led by a former president and hundreds of his endorsed extremists on the ballot across the country. The Dobbs decision drove home the real-life implications of a conservative Supreme Court.
While inflation, gas prices and crime may have mobilized the Red Army to vote, Trump, election denial, insurrection, and Dobbs were more than enough to offset that, mobilizing Blue Army turnout. The results were roughly 50–50 just like the last four elections.
The narrow Republican majority in the House resulted from Gov. Ron DeSantis’ gerrymander of House districts in Florida, a failed Democratic redistricting effort in New York, and, of course, help from the Supreme Court, which paused enforcement of the Voting Rights Act provisions intended to help ensure representation of racial minorities in apportioning seats. These factors appeared to shift more than enough seats to Republicans to hand them their House majority.
Running concurrently with this year’s election was the Right’s anti-ESG campaign, which I don’t think played much of a role on the ground, because even their simplistic ideological messaging was too complex for most candidates to handle.
Nevertheless, with the Republicans now holding a House majority, expect them to amplify their opposition to all things ESG. Or at least try. More on that below.
Expect the DOL final rule any day now and a long legal slog for the SEC climate-disclosure rule
Meanwhile, the Biden Administration has four rules in the process of being finalized. The first, expected to be published in final form any day now, is the Department of Labor rule called “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights”.
The rule will address both “ESG as process” and “ESG as product”. It will make clear that ERISA plan fiduciaries should consider material climate change and ESG-related factors in their investment decision-making process. It will also make clear that sustainable funds can be used as the default investments on plan menus, opening the door for retirement plans to use target-date funds that explicitly use ESG criteria.
The Securities and Exchange Commission, is finalizing two rules pertaining to sustainable funds, titled “Investment Company Names” and “Enhanced Disclosures by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices”.
The names rule tightens the requirement that fund portfolios must reflect what’s implied by the fund’s name. Any fund that has “ESG”, “Sustainable”, “Impact” or similar terms must have at least 80% of assets invested in securities that fit that description. There are some issues with this; namely, the assumption that an “ESG stock”, for example, is a real thing. But as long as 80% of assets are selected based on a process that emphasizes ESG criteria, that should pass muster.
The disclosure rule would require funds to disclose more about how they use ESG. Those that simply use ESG as part of their process, which the SEC calls “ESG integration” funds, would have to detail the role ESG plays in the investment process. Those that hold themselves out to be “ESG” or “sustainable” or “impact” funds would have to detail the approach or approaches they use.
And then there is climate. The proposed rule, titled “Enhancement and Standardization of Climate-Related Disclosures for Investors” would require public companies to report Scope 1 and Scope 2 greenhouse gas emissions and disclose material climate-related risks. The latter, in some cases, would require Scope 3 emissions disclosures.
Don’t expect any of the SEC’s proposed rules to be finalized until next year. All three are delayed because a glitch in the SEC’s system for receiving public comments resulted in the commission reopening the public comment period in October.
Of the proposed rules, the SEC names rule and ESG disclosure rule are generating internal debate within the investment industry, typical of many administrative rules, but shouldn’t attract much attention on the Right. After all, these rules are just trying to make it more transparent to fund investors when a fund is using ESG criteria.
The DOL rule, by contrast, is not controversial within the investment industry, but is sure to rile up the anti-ESG Right, especially because it is expected to make clear that proxy voting is also an area where retirement plan administrators can consider ESG. One of the things animating the Right’s opposition to ESG is the success shareholders have had on ESG-related issues in the engagement and proxy voting process in recent years.
The climate rule is a doozy. The investment industry generally supports it, but corporates worry about the complexity and costs of disclosure. And because the climate policy of the Republican Party is Do Nothing, the Right is sure to go to the mat fighting this rule. They don’t have the power to do it legislatively, so it will be done in court, where they appear to have significant allies among conservative federal judges and justices.
With its ruling in West Virginia v. EPA last summer, the conservative Supreme Court conjured a new “major questions” doctrine that limits the scope of administrative rulemaking on so-called major issues when Congress hasn’t explicitly delegated policymaking to federal agencies.
The SEC’s position is that climate change poses an investment risk, as defined by investors, so the SEC has the power to require climate-related disclosure in order to provide investors the information they need to make prudent decisions. Congress long ago delegated to the SEC the power to require material risk disclosure.
So expect the climate rule, once finalized, to become mired in lengthy litigation, all while global temperatures continue to rise.
The House investigates …
And what about that thin House Republican majority? With Democrats in control of the Senate and White House, Republicans in the House can try to amplify the Right’s anti-ESG campaign through the oversight function afforded to Congress. But Republicans have other fish to fry on the oversight front, namely, investigating major threats to the Republic like Hunter Biden, so it’s unclear where trashing ESG stands on their oversight agenda.
Why Anti-ESG is a political loser
I say, bring it on, because amplifying ESG will ultimately help Democrats more than Republicans. Keep in mind that the political calculus for emphasizing any issue today is whether it can be used to generate voter turnout. The pro-ESG position, as it would be argued in the public sphere, is that companies should, of course, disclose their climate-related risks because climate change is real and needs to be urgently addressed, for investors and in general. Another key component of the pro-ESG position is that corporations should treat their workers better, because it’s not only the right thing to do, companies with loyal, stable workforces are likely to perform better over the long run than those that treat their workers poorly (looking at you, Elon). Amplifying these things will appeal to the Blue Army, especially younger voters.
The anti-ESG position appeals to the do-nothing-on-climate crowd, which is dwindling. Polling by the Yale Program on Climate Change Communication earlier this year found that 68% of registered voters thought corporations and industry should do more to address global warming, not less. Even among conservative Republicans, 38% thought so, and among moderate Republicans, 60% thought so.
The anti-ESG campaign may be appealing to those who think that companies that treat their workers and other stakeholders better are just taking profits away from shareholders. Yet polling by JUST Capital finds widespread support across the political divide for the idea that companies should prioritize workers, which, in turn, drives competitive advantage.
More specifically, the anti-ESG stance appeals to people who are convinced that white males are getting screwed out of jobs by less qualified women and people of color because of “woke” corporate diversity, equity, and inclusion policies. But a survey this year by the Eagleton Center at Rutgers University found large majorities viewed racial and gender diversity as important in the workplace. Among Democrats, 63% thought so, as did 54% of independents. Only 36% of Republicans agreed.
Ultimately, the anti-ESG campaign will be a loser because it wants to limit freedom — the freedom of investors, whether we’re talking about big asset managers or individual investors saving for retirement, to use whatever criteria they deem material to make their decisions. Telling the growing number of sustainability minded people in the world today that they can’t use sustainability criteria in their investment decision-making is a non-starter.
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