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September 5, 2022

Why US banks must be clear about the importance of ESG

A Republican push-back against ESG could force banks to choose between red and blue states, in spite of poor outcomes in Texas.

“ESG is dead on arrival in Florida,” said Ron DeSantis, the state’s governor, as his administration last week passed a resolution he insisted would direct the state’s fund managers to make “sound investments on returns, not woke ideology”. Despite his firm rhetoric, DeSantis’s resolution stops short of banning the consideration of environmental, social and governance (ESG) criteria in investment decisions. The move is, however, part of a growing movement of Republican opposition to sustainable investment, and it will likely impact taxpayers and investors alike.

DeSantis (pictured) is far from alone in the US with his anti-ESG tirades. By July 6, there were at least 44 bills or new laws in 17 conservative-led states – including Oklahoma, West Virginia, Arkansas and Kentucky – demanding a boycott on banks and financial institutions because of their ESG policies, shows research by Reuters. Such efforts are part of the Republican party’s much wider campaign against “woke” culture and policies, from climate action to LGBT+ rights and racial justice.

“So-called ESG policies represent an attempt to impose, through the economy, an ideological agenda that could not win at the ballot box,” said DeSantis in a recent tweet. “We don’t want the values of Davos, we want the values of Destin, Dunedin and DeFuniak Springs,” which are small cities in Florida. The World Economic Forum’s annual meeting of global political and corporate leaders in Davos is seen by many Republicans as a mouthpiece for a progressive agenda they refuse to support.

Texas precedent

Until now, Texas had been the most high-profile state to implement an anti-ESG law. Coming into effect on September 1, 2021, the Texas law bans municipalities from doing business with financial institutions that have ESG policies against fossil fuels and firearms. After Texas passed the law, five of the largest underwriters – JPMorgan Chase, Goldman Sachs, Citigroup, Bank of America and Fidelity – exited the state’s market.

Municipalities were forced to negotiate borrowing terms with other banks. The result? Borrowing costs in Texas increased by about 40 basis points for areas previously reliant on the big financial names, according to analysis by professors at the Wharton School of the University of Pennsylvania. Data from the first eight months of the law’s existence suggests that Texan cities will pay an additional $303mn to $532mn in interest on $32bn in bonds. Unassuming taxpayers will be left to pick up the bill.

Legislating against ESG is tricky given the absence of a globally agreed set of standards. The law in Texas is riddled with loopholes and exceptions. The situation is similarly complicated in Florida, suggests Henrik Jeppesen, head of investor outreach North America for Carbon Tracker, a London-based financial think-tank. “DeSantis’s resolution does not ban or eliminate ESG considerations, as headlines would suggest, but makes it clear that investment decisions must be based on pecuniary factors only,” he explains. “Since ESG issues can have a material effect on the risk and return of an investment, they should still qualify to be considered.”

Against the current

Jeppesen describes Republican attacks on ESG as “political posturing”, an easy way to rally voters against, in their view, “left-leaning people, do-gooders who want to socialise the world and take away all our money”. The potential impacts of such regulations and rhetoric should not, however, be underplayed, he insists. In addition to concerns that taxpayers will end up paying the lion’s share of additional costs, anti-ESG bills could create a fragmented market.

One outcome could be a “bifurcation, where some financial institutions only do business with red states and others with blue states,” according to Jeppesen. Investment managers based in Europe could also find themselves having to apply different analytical approaches to the same companies to comply with increasing political pressure and legal requirements for sustainable finance in Europe, as well as anti-ESG measures in the US.

But the amount of time Republicans can continue to deny the reality of the market may be limited. “You would be hard pressed to find investment managers who are not to some extent integrating ESG factors into their portfolios,” comments Jeppesen. The Principles for Responsible Investment initiative, launched under the auspices of the UN in 2006, has more than 5000 investor signatories, of which more than 1000 are based in the US, managing more than $121tn in assets.

“ESG and anti-woke capitalism are hot topics ahead of the US midterm elections, but bankers and investors should make it clear that ESG integration is about performance,” says Jeppesen.

This article first appeared in The Banker.

A service from the Financial Times