House Republicans continue ESG pushback

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

House Republicans continue ESG pushback

House Republicans again pushed back on the Biden administration’s rule allowing ESG considerations in investments governed by the Employee Retirement Income Security Act of 1974 (ERISA). The House Ways and Means Committee held a hearing on the matter on November 7:

“This committee has a duty to ensure that our tax rules support Americans’ financial security,” said Rep. Jason Smith, R-Mo., chair of the Ways and Means Committee, during a Nov. 7 hearing titled “Ensuring ‘Woke’ Doesn’t Leave Americans Broke.” …

Most of the witnesses Republicans called to testify at the hearing felt similarly to Smith, including Utah State Treasurer Marlo Oaks, who referred to ESG as a dangerous investment scheme.

“ESG has created an uncontrollable impulse to pressure corporations to solve complex global and societal issues,” Oaks said. “These issues, such as climate, income inequality, guns and abortion to name just a few, should be in the purview of a democratically elected government. ESG hijacks corporate governance to advance ideological objectives often divorced from and often detrimental to long-term shareholder value.”

The Republicans on the committee released a statement after the hearing arguing that, in their view, opposing ESG is important for maximizing retirement savings:

At a Ways and Means hearing exploring the infiltration of ESG (environmental, social, and governance) ideology into America’s financial system, witnesses exposed how the Biden Administration’s climate alarmism is allowing ESG activists to threaten the $33 trillion Americans have saved in pensions, annuities, IRAs and 401(k) plans. Increasingly common and pervasive ESG mandates are forcing seniors and savers to pay more in management fees, while earning less. Over the past year, according to a Ways & Means Committee staff analysis, the 20 largest ESG funds lost money and performed nearly 19 percentage points worse than the benchmark S&P 500 index.

Despite ESG’s poor financial performance, the Biden Administration created a pro-ESG rule in 2022, opening the door for asset managers to invest retirement savings in pursuit of climate goals instead of a secure retirement for their clients. During the hearing, the Committee heard how this move has financially benefited countries such as China and Iran, will hurt family farmers, and shift America’s financial systems from one focused on maximizing returns to instead financing radical climate goals.

Americans expect and are legally entitled to have their retirement savings invested for maximum financial returns. ESG funds have a track record of delivering lower returns and costing more to manage.

European ESG regulations may require American companies to comply

The Washington Examiner ran an op-ed on November 9 by Paul Fitzpatrick, the president of the 1792 Exchange and an ESG opponent, who argued that American businesses may have to comply with new ESG rules from the European Union:

Right now, ESG is baked into the new European Corporate Sustainability Reporting Directive and the International Sustainability Standards Board proposals. The CSRD will begin affecting multinational corporations in fiscal year 2024 and can deny American companies access to the important European market. Even companies that don’t operate in Europe will eventually be forced to comply if they are downstream suppliers for the vendors of larger companies.

To add insult to injury, a United States House committee is investigating the Biden administration’s SEC for quietly working with its European Union counterparts to make European regulations as impactful as possible. In the process, the SEC is, as several U.S. lawmakers observed, “willfully circumventing the U.S. regulatory process by actively coordinating with foreign governments to dictate climate and economic policy to U.S. companies.” At the same time, the SEC has proposed its crushing Climate Disclosure Rule. …

Europeans, in particular, are bearing the brunt of [ESG] every single day. The EU and individual nations’ overreach has increased costs for food, made energy more expensive and less reliable, manipulated transportation, choked the economy, increased reliance on Russia and China, and changed the political landscape across Europe.

Bloomberg News, which is generally supportive of ESG, also says American multinational companies are likely to face additional regulatory hurdles in 2024:

Companies based outside Europe are reviewing securities they’ve listed in the bloc, as the implications of an overlooked clause in new ESG reporting rules sink in.

International companies that have issued stocks and bonds in the EU may need to comply with Europe’s Corporate Sustainability Reporting Directive (CSRD) as soon as January, according to lawyers advising corporate clients affected by the new rules. That’s four years earlier than many had expected, and may drive a number of non-EU companies to cancel their EU securities, the lawyers said. …

There are more than 1,000 CSRD reporting requirements covering a range of environmental, social and governance factors. Lawmakers in the US and the EU have argued that elements of the requirement, which also involve corporate value chains, are too onerous. But CSRD disclosures remain on track to go into effect next year, after a last-ditch effort by some EU lawmakers to derail the process fell flat.

France prohibits ESG funds from investing in growing fossil fuel producers

The French government announced last week that investment funds in the country that call themselves ESG-friendly (that receive the SRI label under French law) will have to divest from fossil fuel companies “that are expanding production.”

Finance Minister Bruno Le Maire said excluding oil and gas companies with expansion plans is “essential” to fighting climate change, according to a statement on Tuesday. The change will make it easier for green investors to know what they’re really getting, he said. …

France joins Belgium in taking a tougher stance on fossil fuel investments. The Belgian Central Labeling Agency said earlier this year that companies held in ESG funds can’t be involved in exploration or development of new fields. …

The French government’s decision to crack down on fossil-fuel companies follows a two-year review of the SRI label criteria, which faced criticism from members of the finance industry including Amundi SA, Europe’s biggest asset manager.

In the spotlight

ESG may hurt environmental and financial performance, according to study

Opponents have often questioned ESG’s profitability and environmental impact. For example, Stephen Soukup, an ESG opponent and the author of The Dictatorship of Woke Capital, has argued the “core promise of ESG—that it enables investors to do well by doing good—is a lie on both ends.”  Soukup claims the evidence shows, in his view, “ESG investors neither do particularly well (in terms of returns) nor do very much good.”

Fortune magazine last week released the results of an examination of 235 companies conducted by Christos Makridis and Majeed Simaan. The study argued that “the explicit targeting of ESG metrics leads to a portfolio allocation that is economically and environmentally worse than the market allocation” and that “[i]nvestors should be wary of overemphasizing ESG at the expense of established measures that have stood the test of time.”

After gathering the subset of stocks that were traded on a daily basis between 1998 and 2020 on the three major exchanges as well as ESG data, we quantitatively studied the inclusion of ESG metrics in two ways. First, we consider trading strategies that only rely on returns, rather than a combination of returns and ESG scores. We found that non-ESG rules that incorporate returns result in higher ESG scores, compared with ESG-based rules.

Second, we considered trading strategies that prioritize the stocks with the highest overall ESG score, reflecting the increased attention that ESG has received in recent years. We found that it does not result in the most efficient portfolio in terms of risk-adjusted returns. While including ESG data leads to portfolios with higher returns, it was at the cost of more volatility.

Our results may come as a surprise: Because of the noise inherent in ESG metrics, including them creates estimation risk and worsens the portfolio allocation. In fact, we find that the explicit targeting of ESG metrics leads to a portfolio allocation that is economically and environmentally worse than the market allocation. That is consistent with prior research that finds substantial disagreement among ESG ratings agencies due to their chosen ESG metrics, how they measure the metrics, and how they weight across the metrics in forming overall scores. Our results are also consistent with recent research that has shown how the inclusion of uncertainty associated with an ESG metric lowers financial returns.

Fortune and the CEO of Fortune Media, Alan Murray, have previously expressed support for ESG investing.