Economy and Society: The Labor Department and ESG

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., and around the world

The Labor Department continues to ponder its ESG role

The Biden administration Department of Labor made news last year when it overturned a Trump-era advisory statement to retirement-plan managers regarding ESG in ERISA (Employee Retirement Income Security Act)-covered plans. Now, it appears that the Labor Department is extending its inquiry into ESG and the role it might play in the investment products the Department regulates:

“The Department of Labor under the Biden administration has made environmental, social and governance investing a key focus during its first year-plus in office and is now seeking public input on a wide array of questions around climate change and retirement savings that could lead to further guidance or requirements, industry sources said.

Following a May 2021 executive order from President Joe Biden that directed federal agencies to assess and mitigate financial risks related to climate change, the Labor Department’s Employee Benefits Security Administration issued a request for information last month asking the public what it should do to “protect retirement savings and pensions from risks associated with changes in climate.”…

The executive order on which the RFI [request for information] is based calls on the Labor Department to identify actions it can take under the Employee Retirement Income Security Act of 1974 and the Federal Employees’ Retirement System Act of 1986 to mitigate climate risks.

The RFI includes 22 questions that delve into a range of topics, from data collection: should EBSA use Form 5500 annual returns/reports to collect data on climate-related financial risk to pension plans?; to lifetime income products: do any guaranteed lifetime income products (e.g., annuities) help individuals efficiently mitigate the effects of at least some climate-related financial risk?; to oversight of the $780.6 billion Thrift Savings Plan, Washington: what actions, if any, should the TSP’s asset managers take to incorporate climate-related financial risk, consistent with FERSA’s terms and their duty of prudence?”

This expanded inquiry has some concerned that the Labor Department may be pushing too far on the ESG question:

“Will Hansen, Arlington, Va.-based executive director of the Plan Sponsor Council of America and chief government affairs officer at the American Retirement Association, is concerned that the Labor Department could require plan sponsors to disclose their analysis of environmental factors on a Form 5500.

“Any attempt to make that information available on a publicly available form is then opening up the plan sponsors to future litigation,” Mr. Hansen said. “I do have concerns that mandating any sort of new information on a Form 5500 that could be subjective is going to create a whole new era of frivolous litigation against plan sponsors.””

Additionally, it appears that the Labor Department is taking aim with its RFI (request for information) at the government’s own retirement plan, the Thrift Savings Plan:

“The Labor Department in its RFI posed several questions on the Federal Employees’ Retirement System Act of 1986; the Federal Retirement Thrift Investment Board; and the Thrift Savings Plan, the retirement system for 6.5 million federal employees and members of the uniformed services.

Referencing a 2021 Government Accountability Office report that said the Thrift board, which administers the TSP, “has not taken steps to assess the risks to TSP’s investments from climate change as part of its process for evaluating investment options,” the Labor Department asked what data, if any, should the Thrift board collect on TSP’s exposure to climate-related financial risk. The DOL also asked what types of data, if any, should it collect from asset managers regarding climate-related financial risk.

Mr. Campbell noted that the Labor Department has oversight authority with respect to the TSP, but it does not have enforcement or policymaking authority.”

ESG goes to war, continued

The fallout from the Russia-Ukraine war continues to impact ESG investors and the very concept of ESG itself. On March 10, The Financial Times cited a European finance expert who argued that, in their words, ESG failed the test that Russia provided:

“Russia’s invasion of Ukraine has exposed the failings of asset managers and data analytics firms in their assessment of environmental, social and governance risks, according to a senior sustainable finance executive.

Vladimir Putin’s war in Ukraine has prompted some asset managers to stop new investments in Russia, while others have said they will divest from the country when they are able to do so.

However, Sasja Beslik, a sustainable finance expert, said the war showed that ESG investors “have failed” by not managing risks associated with Russian investments before the latest invasion.

Beslik said companies should have learned from Russia’s annexation of Crimea in 2014.

Most fund managers and ESG analytics firms “did nothing” eight years ago, said the former head of responsible investments at Nordea Asset Management.”

Meanwhile, other problems derived from ESG practices began to manifest in the face of the war, including some issues with the practice of using ESG in passive investments. Last Thursday, Bloomberg reported the following about two ESG giants, noting that ESG index funds added Russian holdings just before invasion:

“As Vladimir Putin amassed military forces on Ukraine’s borders in January, Vanguard Group and Northern Trust Corp. increased their holdings in Russia’s leading bank via some unlikely portfolios: their ESG funds, which invest with a mandate to minimize “environmental, social and governance” risks.

Big asset managers, including Blackrock Inc., State Street Corp. and Amundi SA, also hold shares via ESG funds in Sberbank PJSC, and in Russian oil companies Gazprom PJSC and Rosneft PJSC, according to data compiled by Bloomberg. In total, ESG funds held at least $8.3 billion in Russian assets before Putin invaded Ukraine.

The Northern Trust and Vanguard portfolios, which meet the official European standards for a sustainability label, are index funds, and the uptick in Sberbank holdings was probably tied to a rebalancing of stocks in the index or distribution of new money, not an active choice based on the company’s fundamentals. But the timing, just weeks before Russia’s invasion of Ukraine, and now the challenges of dumping Russian stocks point to one of the challenges of passive investing for ESG investors.

“Passive investing and sustainable investing aren’t good bedfellows,” said Jack Nelson, portfolio manager at Stewart Investors’ Sustainable Funds Group. “If you’re investing in an active fund, you can make a judgment. If you’re doing it passively, you’re switching into a robot.”…

Once limited to broad market portfolios like the S&P 500, the explosion of niche index products has made it possible — and cost-effective — for ESG investors to adopt the same strategy. ESG indexes provided by firms like FTSE Russell and MSCI Inc., and the funds that track them, favor companies with high ESG ratings, underweight those that score poorly, and screen for additional problem sectors such as weapons, coal and tobacco. 

This means that even stocks with traditionally low ESG credentials, such as fossil-fuel companies or autocratic state-owned banks, find their way into ESG-labeled funds. As the fund grows, or the poorly rated companies do, those positions increase. 

Sustainable funds, including ESG offerings, collectively oversee about $2.7 trillion worth of assets. But as the broad category has grown in its appeal, the industry has come under fire for failing to match its rhetoric with changes in the real economy, and remains divided on its purpose and methods. The death toll in Ukraine has surfaced those divisions again and with new urgency.”

Additionally, because of the scrutiny applied to ESG providers with respect to Russia, other investments are being scrutinized by various outlets. Here, for example, Bloomberg notes ESG connections to Myanmar and its ongoing internal struggles:

“Hundreds of ESG funds run by some of the world’s biggest money managers have a combined $13.4 billion stake in companies that supply weapons and technology to the Myanmar military, according to a report.

The funds, which say they take into account environmental, social and governance risks, have investments across 33 companies that the United Nations and two advocacy groups say provided weapons, communications and technologies to the military, Inclusive Development International and ALTSEAN-Burma said in a report released Wednesday.

The report comes as investors, particularly in the ESG universe, face new questions about how they should approach armed conflicts. Roughly 14% of sustainable funds globally held Russian assets before the war began, an allocation that now looks questionable on principle and in practice….

David Pred, executive director of Inclusive Development International, said there’s no place for arms manufacturers in ESG funds, “full stop.” 

“And certainly not companies that supply regimes that are using those weapons on innocent civilians and for non-defensive purposes,” he said. “For us, it is about the human impact of the company and its product, there’s just no reasonable argument for arms makers to be in these funds.””

In the spotlight

Elon Musk pushback against ESG

While some providers (and ratings services) love Tesla for its electric vehicles, others shy away from the company because of its perceived poor history of reporting ESG data and its eccentric CEO Elon Musk. Now, Musk is pushing back:

“Tesla and SpaceX CEO Elon Musk has said corporate rules designed to guide ethical investing have been ‘twisted to insanity’ and should be ‘deleted if not fixed.’

Elon weighed into a debate on whether ethical rules should be updated to allow for investment in defensive weapons amid Russia’s invasion of Ukraine. 

Musk was criticizing ESG, a European Union-sponsored checklist of ‘environmental, social and governance’ criteria companies are supposed to keep in mind when making decisions about what to invest in. Along with entrepreneur and software engineer Marc Andreessen, he mocked the ‘ethical’ rules on Twitter after the suggestion they could now be changed to allow for investment in weapons used against Russia.

Under the European Green Deal, the EU provides a list of what sectors are considered ‘green’ or ‘ESG.’

Normally, companies exclude investing in firearms to win an ‘ESG’ stamp, but US banks are now suggesting the EU could classify the defense sector as an ethical investment – as long as it was used against Putin.

Andreessen tweeted out a screenshot on Tuesday of a Reuters article which referenced a note from analysts at Citigroup.

Citigroup said defense is ‘likely to be increasingly seen as a necessity that facilitates ESG as an enterprise, as well as maintaining peace, stability and other social goods’ following Russia’s invasion of Ukraine. 

On the other hand, energy companies seen to be supporting Russia will be considered unethical under the same framework.

Andreessen said: ‘The plan: ESG funds will invest in defense companies to make the weapons required to fight wars with hostile regimes we buy energy from, because ESG funds won’t invest in energy companies.’

Musk tweeted in response that ESG rules were being ‘twisted to insanity’, condemning the criteria which has been pushed by both the EU and the Biden administration.

They should be ‘deleted if not fixed,’ he added.”