Economy and Society: Opponents respond to proposed Labor Department ESG rule

Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the Environmental, Social, and Corporate Governance (ESG) trends and events that characterize the growing intersection between business and politics.

ESG Developments This Week

In Washington, D.C.

ESG opponents offer arguments against proposed Labor Department rule

The Biden Labor Department’s proposed rule on ESG investments in ERISA-governed retirement plans, mentioned in last week’s newsletter, generated additional pushback over the past week. Below is a selection of responses from ESG opponents. 

Journalist Charles Gasparino focused his commentary for Fox Business (and his follow-up for The New York Post) on asset management firm BlackRock and what he described as its influence on the Biden administration:

“The world’s largest money management firm, with more than $9 trillion under assets, stands to profit from a government adoption of new environmental and social governance standards, FOX Business has learned.

BlackRock has been forging a new path into so-called Environmental Social Governance, or ESG investing, nearly tripling its ESG offerings in the past year. The company now offers more than 150 mutual funds and exchange traded funds (ETF) that adhere to ESG standards – more than any other firm on Wall Street – and manages more than $400 billion in ESG client money….

A newly proposed rule by the Labor Department that could force U.S. companies to offer ESG funds into their employees’ 401K plans has promising implications for BlackRock. If the rule were to pass, workers and businesses would become more heavily involved in ESG investing and BlackRock as the industry leader for ESG ETFs would profit. 

What’s more, investing in ESG funds, including BlackRock’s exchange traded funds, carry management fees as much as 40% higher than regular ETFs….

The likelihood of the 401K rule passing is unclear, but BlackRock has close ties within the Biden administration and that could help push the move through the necessary channels….

Brian Deese, Biden’s national economic council chief, was formerly global head of sustainable investing at BlackRock. Deese also has as much as $100,000 in each of seven BlackRock ETFs and in 2020 received a $2.3 million salary from the company and earned a further $2.4 million from his vested restricted shares in the company. 

Deese also has a 401K account with BlackRock, according to his financial disclosures that were updated in March of 2021.  

Wally Adeyemo holds the position of deputy Treasury Secretary but was Fink’s chief of staff and a senior adviser at the firm before joining the administration. Adeyemo holds between $250,000 and $500,000 worth of company stock according to his 2020 financial disclosures and his close ties to Fink and the company could help tilt the scales in favor of ESG implementation, lobbyists tell FOX Business. 

Other BlackRock alum serving in the Biden administration is Michael Pyle, BlackRock’s former global chief investment strategist who is now serving as chief economic adviser to Vice President Kamala Harris. Pyle also worked in the Obama administration as a special assistant to the president on economic policy matters.

Tom Donilon is chairman of the BlackRock Investment Institute and held previous positions in the Obama, Clinton and Carter administrations. His brother, Mike Donilon, is Biden’s senior adviser and was also the chief strategist on his campaign.”

Lawrence A. Cunningham, a professor at George Washington University, and founder of the Quality Shareholders Group, wrote in MarketWatch, a Dow Jones publication, that the proposed rule could, in his view, hurt workers:

“[I]n 1994, the Clinton administration opened the door to allow managers to consider social factors in their investment picks too, then known as “economically targeted investments” (ETIs), at least when related to financial considerations.  In 2008 and again in 2015, the Obama administration opened the door further by condoning “environmental, social and governance” (ESG) factors as part of an investment process.

Perceiving excessive departures from the investment mandate into contentious political topics from climate change to race to political donations, the Trump administration began to close the door. In 2018, it advised that managers should not too readily treat ESG factors as economically relevant to investment analysis. In 2020, the government functionally shut the door, prioritizing risk and return, requiring non-ESG investments be considered in every plan, and mandating specific explanations for choosing any ESG alternative. 

Now, the Biden administration wants not only to reverse the Trump guidance but go further than Clinton or Obama ever did. In rules just recently proposed, the Department of Labor says it “may often require an evaluation of the economic effects of climate change and other ESG factors on the particular investment or investment course of action” (emphasis added). 

In lengthy elaboration, it is therefore clear that the Biden proposal would mandate that retirement fund managers incorporate ESG factors into investment analysis. It says this is “intended to counteract negative perception of the use of . . . ESG factors in investment decisions” left by the Trump administration.

All these political incursions into investment processes and stewardship are misguided….

Politicians in the White House and their administrative appointees lack the competence to tell investment professionals how to conduct their investment analysis or to limit or expand their purview. It is certainly outside their competence to direct American workers how their funds should be managed. When politicians and ideologues do so, it is the investors in those funds — American workers — who lose. 

The Biden administration acknowledges as much. Lacking expertise of their own, they report reaching out informally to numerous unnamed interested parties, including asset managers, plan sponsors, consumer groups, and investment advisers. In theory, outreach is the right approach, but a representative sampling across those and other relevant groups, such as employees, will not yield a consensus view favoring or opposing ESG investing (let alone agreement on exactly what that means).”

Rupert Darwall, a senior fellow at RealClearFoundation, writing at RealClearEnergy, argued that the proposed rule’s special documentary requirement could have what he described as a “chilling effect”:

“[T]he DOL published its proposed rulemaking earlier this month. The outcome is a model of everything a rule should not be: ambiguous, at times contradictory, and, most deleterious of all, dissembling in its claim to uphold the letter of the law when the intent and effect of the rule – if finalized – is to weaken it. When Congress wrote the ERISA legislation in 1974, it was determined that pension plan fiduciaries, who manage retirement income plans on behalf of plan beneficiaries, act solely in the financial interests of those beneficiaries. Section 404 of the act is tightly drafted to require plan fiduciaries to discharge their duties for the exclusive purpose of providing benefits to plan participants and plan beneficiaries and defraying reasonable expenses of so doing.

“The fundamental principle is that an ERISA fiduciary’s evaluation of plan investments must be focused solely on economic considerations that have a material effect on the risk and return of an investment based on appropriate investment horizons,” the November 2020 financial factors rule stated. “The corollary principle is that ERISA fiduciaries must never sacrifice investment returns, take on additional investment risk, or pay higher fees to promote non-pecuniary benefits or goals.” In operationalizing these two principles, the financial factors rule was designed to show how plan managers can be assured they are acting as they are legally required to. There was little novel in the Trump DOL’s articulation of these principles. A 2015 DOL interpretative bulletin issued during the Obama presidency advised plan fiduciaries that they “may not use plan assets to promote social, environmental, or other public policy causes at the expense of the financial interests of the plan’s participants and beneficiaries. Fiduciaries may not accept lower expected returns or take greater risks in order to secure collateral benefits.”…

The replacement rule, the DOL claims, is needed because the current one “has created a perception that fiduciaries are at risk if they include any ESG factors in the financial evaluation of plan investments.” Many stakeholders, it says, “misperceive” that consideration of ESG factors is banned except in cases of a tiebreaker. Not really: the financial-factors rule explicitly acknowledges that “ESG factors can be pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.” In the proposed replacement, the DOL says that ESG is the one category of investment singled out for special documentation….

The special documentary requirement of the current rule arises in rare cases when a plan manager can’t distinguish between two alternatives based on pecuniary factors alone. In these circumstances, a non-pecuniary factor can be used as a tiebreaker provided that the manager fully documents the factors leading to the selection. This documentary requirement, the DOL claims, could have a “chilling effect.”…”

On Wall Street and in the private sector

Is an ESG bubble about to burst?

Twice in the past several weeks, heads of large financial institutes warned that ESG would createor, in one case, already has createdsignificant investment bubbles. On Thursday, October 21, the president of the Institute of International Finance urged caution:

“Speaking during a panel at CNBC’s Sustainable Future Forum on Thursday, Adams said it was inevitable that the current drive toward ESG (environmental, social and governance) would create assets that exceeded their fundamental value.

“There’s always bubbles, it’s a lesson of history. Anyone who thinks we won’t have it is naïve,” he said.

“In times of great technological or economic transformation there’s disruption, there’s bubbles, we see it in the crypto markets now. We saw in the internet throughout the 1990s that all popped in March of 2000. And the weak firms were washed out and new firms rose like a phoenix. Yes, there’s going to be bubbles — there’s too much money chasing too few deals.”

Having appropriate policies and a resilient financial system in place when the bubble pops, Adams added, would allow investment into promising firms in the space to continue.”

Meanwhile, the Swiss Finance Institute of Finance released a report making the case that ESG, as an investment segment, is already a bubble and could pop:

“The doing-well-by-doing-good conviction driving ESG investors around the world is nothing more than an illusion of their own making, according to a controversial new study.

Research from the Swiss Finance Institute argues stocks highly rated on environmental, social and governance metrics have outperformed in recent years all thanks to the trillions of dollars flooding the sector. The fundamentals of socially responsible investing have played no role in driving these returns.

In fact, ESG bets would have backfired spectacularly without this influx of cash — leaving Wall Street portfolios at the mercy of volatile capital flows.

“Under the absence of flow-driven price pressure, the aggregate ESG industry would have strongly underperformed the market from 2016 to 2021,” Philippe van der Beck said in the “Flow-Driven ESG Returns” paper published this month. “If however, ESG inflows unexpectedly revert, the realized future return may be strongly negative.”…

To the researcher, the point is that flows have so far driven industry performance — more than commonly acknowledged. Just as retail traders were able to power seemingly deadbeat companies to dizzying highs this year from GameStop Corp. to AMC Entertainment Holdings Inc., prices of stocks bought by ESG investors will naturally rise — even without any fundamental justification.”

In the spotlight

ESG reverberates beyond the markets: new review of The Dictatorship of Woke Capital: How Political Correctness Captured Big Business by Stephen R. Soukup

The Fall, 2021 edition of American Affairs, a journal of culture, philosophy, and politics contains a 4300-word review of The Dictatorship of Woke Capital, by Stephen R. Soukup, a book, at its heart, about stakeholder capitalism and ESG investing. Though the review, written by Ronald W. Dworkin, is, more than anything, a discourse on dialectics and examines Soukup’s unwillingness to use the term to explain what he described as “woke capital,” one would be hard-pressed to find many books about markets and investing in the pages of such journals.  ESG appears to be something different altogether. From the review:

“[I]f Soukup had paid more attention to Marx, he might have found a better way to explain “woke capital”—and to fight it. In a supreme irony, those seeking to advance a center-right agenda today could benefit from reading Marx.

Marx thought dialectically. What does this mean? Take a certain social phenomenon: it develops to its utmost limits, makes use of all its potentialities, creates the highest thing it can, and stops. This is called the thesis. Then comes the antithesis, a hostile force. It also unfolds to the very end, and stops. Born out of these two hostile phenomena is a third force, the synthesis, making use of the result achieved by both, and reconciling them. And society moves forward again, always forward, toward the new.

A rough dialectical history of the United States since the end of the Civil War might be said to unfold as follows, with woke capitalism the most recent entry. In 1870, most Americans worked as independent small farmers. Most business firms were also small, with one or two employees besides the owner. A culture of individualism and a religious ethos that gently repressed greed complemented this economy. The country prospered, yet the economy’s small scale limited how much it could produce. This was the thesis.

Hostile forces emerged in the form of robber barons who built large corporations, sometimes through deceit and manipulation. A culture of social Darwinism that equated worldly success with spirit­ual superiority replaced the older, more innocent religious ethos. Many Americans found themselves subject to both the vicissitudes of the market and business chicanery, as large companies undercut their ability to make a living as independent operators. Indeed, one of the most important changes in the U.S. economy during the second half of the nineteenth century was the dramatic increase in the size of the average enterprise, along with a reduction in the number of firms in each sector. The new system produced more wealth than before through improved economies of scale, yet its boisterous atmosphere created uncertainty, and it soon reached its productive limits. This was the antithesis. Corporate America and welfare-state liberalism were the synthesis.”