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Op-Ed: ESG
investing – politics by other means
[The Center Square] Rupert Darwall |
RealClearWire
Before Joe Biden’s
election, environmental, social and governance (ESG) investing was
sweeping all before it. Wall Street was coming to the planet’s rescue
and saving capitalism at the same time. It was a self-serving myth. As I
show in my new report, Capitalism, Socialism and ESG published today,
doing well by doing good is no more than Wall Street sales patter. But
since the election, financial regulators have been falling over
themselves playing catchup. |
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 In early December, Fed governors voted unanimously to join the
Network for the Greening of the Financial System, a club of central bankers and
financial regulators established by the Banque de France to implement the Paris
climate agreement. Acting SEC chair Allison Herren Lee has put climate and ESG
front and center of the SEC’s work. “No single issue has been more pressing for
me than ensuring that the SEC is fully engaged in confronting the risks and
opportunities that climate and ESG pose for investors, our financial system, and
our economy,” she says.
At the Department of Labor (DOL), it was widely expected that
the new administration would use the Congressional Review Act to scrub out two
late-term Trump administration ESG rules governing corporate retiree-savings
plans under the 1974 Employee Retirement Income Security Act (ERISA). Instead,
the DOL announced that it merely intends to “revisit” the rules. Pending that
process, it would not be enforcing them.
Why?
The DOL’s position is unconventional, to say the least. The first constitutional
duty of the executive is to enforce the law. A trio of Republican senators –
Richard Burr, Mike Crapo, and Pat Toomey – have criticized the DOL’s decision to
abdicate its legal responsibility to enforce ERISA and the rules that
operationalize its provisions to protect retiree incomes.
The DOL finds itself between a rock and a hard place. The hard place is
President Biden’s first executive order instructing federal agencies to suspend,
revise, or rescind (not revisit) Trump administration regulations that conflict
with, to use shorthand, the ESG and climate policies of the Biden
administration. The rock is the letter of the law. ERISA imposes tightly defined
duties on plan managers and fiduciaries to act solely in the interests of plan
beneficiaries and must set out to maximize the risk-adjusted financial value of
plan assets, considering only so-called pecuniary factors when making investment
decisions.
The essence of the DOL’s financial factors rule is to clarify the legal duty of
plan managers not to subordinate the financial interests of plan participants to
other objectives or promote non-pecuniary goals. “The weight given to any
pecuniary factor by a fiduciary should appropriately reflect a prudent
assessment of its impact on risk-return,” the rule states. In a tie-break where
the pecuniary factors are indistinguishable between two alternatives, the rule
requires plan managers to document why the pecuniary attributes of the two
alternatives cannot meaningfully be distinguished. ESG advocates
would have us believe that incorporating ESG factors boosts financial returns –
or, as the ESG sales patter has it, “doing well by doing good.” Were the
superiority of ESG investing strategies clear-cut and supported by generally
accepted investment theories, the rule would present little difficulty to a
competent investment manager. Yet according to the Biden DOL, the new rule is
having a “chilling effect” on integrating ESG factors into investment decisions.
This is not surprising. Modern investment theory emphasizes the importance of
portfolio diversification. The MSCI KLD 400 Social Index, used by BlackRock’s
iShares MSCI KLD 400 Social Index, comprises less than one-fifth of the MSCI USA
IMI Index. No investment theory says that shrinking the universe of potential
investment options by 80% is conducive to producing higher returns. The 2000
decision by CalPERS, the nation’s largest state pension fund, to divest itself
of tobacco stocks is reckoned to have cost it $3 billion in lost returns.
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Insofar as material ESG factors boost corporate
profits, ESG investment strategies must assume that the market fails
to incorporate this into higher valuations because once the market
has priced in those factors, investors must be satisfied with lower
expected returns. As Eugene Fama, a founder of modern portfolio
theory, puts it, “virtue is its own reward since investors get lower
expected returns from the shares of virtuous firms.” In terms of
compliance with ERISA, virtue is a non-pecuniary benefit.
Ostensibly, much of the planned regulatory action is about more
disclosure enabling investors to make better investment decisions,
especially on climate change. But the notion of climate risk
requiring additional disclosure is deeply suspect. Was February’s
energy whiteout in Texas a climate change physical risk – or a
climate change regulatory risk, arising from over-investment in wind
and under-investment in coal and nuclear making the Texas grid less
resilient? These are questions for climate risk theologians but of
little real-world relevance to investors. Much
climate disclosure required by ESG standard-setters is
systematically misleading because it treats the world as a
homogenous regulatory space. Climate regulations are made by nation
states; it is highly unlikely that a corporation’s global footprint
is coterminous with the borders of a state.
In reality, climate risk disclosure is about facilitating and
encouraging non-state actors to regulate corporations and thereby
society. As BlackRock CEO Larry Fink says, it isn’t transparency for
transparency’s sake; “disclosure should be a means to achieving a
more sustainable and inclusive capitalism.” The SEC is giving
activist investors the green light to table shareholder motions to
force ConocoPhillips and Occidental Petroleum to set out detailed
plans for cutting Scope 3 emissions – those emitted by their
customers. BlackRock, the world’s largest fund manager, is
pressuring companies to formulate business plans “consistent with
achieving net-zero global greenhouse gas emissions by 2050.”
ESG investing thus turns out to be politics continued by other
means. Far from a vision of inclusive capitalism, it is the
culmination of a trend away from democratically accountable
law-making. In 2009, despite large Democratic majorities in both
houses of Congress, cap-and-trade was passed only narrowly by the
House and died in the Senate. After the 2010 midterm elections, such
efforts became the purview of the administrative state and the Obama
administration’s Clean Power Plan – until the Supreme Court ordered
a stay on its implementation. Now, society is apparently to be
regulated by the top executives of multitrillion-dollar index funds
and a handful of activist shareholders.
 Inclusive it
is not. Americans’ savings are to be deployed for wider societal
ends, ones determined not by them or by elected politicians but by
Wall Street oligarchs. The end point is the socialization of
American capital. Rather than being inclusive, ESG is pure insider
capitalism: it excludes the many from power exercised by the few.
Rupert Darwall is a senior fellow of the RealClear
Foundation and author of Capitalism, Socialism and ESG.
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