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ESG and Fiduciary Duty
The main legal problems the bills create fall into four categories:
(1) the unworkable distinction between “pecuniary” and “non-pecuniary,” a distinction so blurry that the bills are self-contradictory, as we demonstrate;
(2) the clash between the bills’ definition of materiality and that established by the Supreme Court of the United States, such that state law would bar consideration of investment information that federal law requires;
(3) similarly vague and self-contradictory requirements to boycott companies that engage in ESG, and
(4) the transfer of control of proxy voting to elected officials, thereby ensuring the politicization of such voting in direct conflict with the bills’ stated goals.
The boycott bill and the fiduciary duty bill dramatically increase liability risk for plan fiduciaries and service providers without providing any corresponding or even off-setting benefits to fiduciaries or their members. They will reduce the number of service providers willing to work with such pensions, increase liability, insurance, and investment costs for taxpayers, and fund participants and beneficiaries. They should be rejected.
The trustees of the County Employees Retirement System—which represents 64% of Kentucky Retirement System members—approved a letter to the state’s treasurer saying that the new Kentucky law requiring state agencies to disassociate with companies that boycott the energy sector requirements would force CERS to breach its fiduciary duties. The trustees said CERS is therefore not subject to the law’s requirements.
Two persistent misconceptions continue to affect the way fiduciaries think about sustainable investing: (1) fiduciary duties block a fiduciary investor from considering environmental and social factors; and (2) the portfolio will suffer financially if a fiduciary investor engages in sustainable or responsible investing. An examination of socially responsible investing; ESG integration (an investment process that considers material environmental, social, and governance (ESG) factors alongside traditional financial metrics); corporate social responsibility; and impact investing, shows that neither of these assumptions is correct.
Analyses of different forms of sustainable investing have found no necessary cost to a portfolio when sustainable funds are compared with traditional funds.
Since the duty of impartiality protects future beneficiaries, that duty requires a long-term investment time horizon, increasing the need to take ESG information into consideration. It follows that a prudent fiduciary investor not only may, but should, use ESG information in developing financial policy and decisions.
We conclude that fiduciaries, when voting, monitoring or advising on voting, must apply an up-to-date understanding of fiduciary duties and must correspondingly evaluate how ESG factors and systemic risks can often be material economic issues at individual companies and across industries.
ESG and Performance
On March 30, attorneys general from 21 Republican-led states sent a letter to 53 leading asset managers warning about "potential unlawful coordination" from their participation in initiatives such as the Net Zero Asset Managers Initiative. The coalition of firms that joined the group promised to decarbonize their portfolios such that assets under management have net-zero emissions by 2050 in accordance with the Paris climate accord. ESG critics allege that such agreements may violate antitrust laws. But their most persistent argument is that ESG investment policies hurt returns, despite a lack of conclusive evidence that this is the case. The S&P 500 ESG index, for example, continues to slightly outperform the standard stock market index.
Topics discussed include:
Implications of the Business Roundtable Statement on Purpose of the Corporation
Evolution of Delaware corporate law regarding ESG and company compliance functions under the Caremark line of cases
The relationship between ESG factors and how companies make money
Research on performance results of managing companies to a long-term strategic plan
Behavioral dynamics that influence the effectiveness of communications between investors and companies
An investor roadmap for driving culture change in boardrooms to improve long-term performance
The continuum of investor strategies for overcoming current regulatory roadblocks to engaging companies on ESG risks and opportunities
Conflicts between short-term interests of fiduciary agents in the investor service provider chain and the long-term financial interests of a fund’s beneficiaries
The difference in returns between stocks of companies with the highest number of people of color on their boards and those with the least was 1.5%
80% of investors still believe that companies with strong ESG practices can generate higher returns and make better long-term investments.
The potential ESG-related revenue uplift for the 1,262 large businesses we spoke to at up to $4 trillion – or $45 million for every firm.
Businesses that express commitment to ESG have seen profits jump 9.1% over the past three years and as many as 84% said that their ability to raise capital had become slightly or significantly easier.
Higher representation of Black, Indigenous, and people of color (BIPOC) employees in management has a positive relationship to a range of financial indicators, including higher cash flow, net profit, three- and five-year revenue, five-year return on equity (ROE), and stock performance.
Five-year ROE has a slight negative association across all sectors when the representation of white managers increases.
Costs of anti-ESG legislation
In April, the city council voted to borrow money for the $13.5 million project from Bank of America, which offered the lowest interest rate. But less than a week later, Oklahoma’s treasurer announced Bank of America was no longer allowed to do business with government entities across the state. The bank was one of 13 deemed to be “boycotting” oil and gas companies in violation of a new state law. The next best lender had an interest rate 0.7% higher, which would cost Stillwater nearly $1.2 million in additional costs.
A recent study by Econsult Solutions Inc., estimated Oklahoma could pay nearly $50 million more in bond interest costs annually because of the ban.
The anti-ESG push in Oklahoma has appeared to hamper the state's business development efforts. Volkswagen recently referenced that opposition in not selecting the state for a new manufacturing plant.
In a rebuke to a movement that’s taken hold in conservative strongholds like Texas and Florida, legislators in the GOP-controlled statehouses of Kansas, Wyoming, North Dakota and Indiana killed or significantly watered down bills that would limit so-called environmental, social and governance investing practices or force governments to sever business relationships with Wall Street firms that espouse the policies.
Details vary state by state, but broadly speaking lawmakers who nixed the plans cited the costs to taxpayers following pushback from public retirement systems.
We expect more states to propose or adopt anti- (and pro-) ESG state laws, particularly as the 2024 U.S. presidential election approaches and political agendas solidify, and as the global ESG regulatory framework, including a growing web of EU-related ESG measures, comes into greater focus.
The scope and nature of such measures will continue to evolve in reaction to the success or failure of similar measures, the availability of data on the financial and non-financial impact of such measures, the continuing debate as to the opportunities and challenges associated with ESG (including with respect to ESG and investor returns, ESG ratings methodologies and measurement challenges, and inconsistencies in current reporting standards), voter interest, organizational influence over lawmaking in state legislatures, and activities at the federal level relating to how fiduciaries can consider ESG factors in investment decisions.
The surge of anti-ESG measures poses significant legal, operational, reputational, political and financial concerns for funds, asset managers and companies that integrate ESG investment into their policies, procedures and disclosures, threatening state contracts and the removal of state funds from investment portfolios and the reinvestment of assets in the first instance. These laws include a variety of different applications and carve-outs, and whether a company is in scope will depend on varied analysis in each state. Monitoring these measures and understanding the nature of conflicting requirements and associated risk will be essential.
As a general matter, these measures are still relatively untested, resulting in considerable uncertainty about their ultimate interpretation and implementation. In some cases, carve-outs may potentially be used to protect investments and avoid compliance violations (at least in respect of entities not yet subject to blacklisting), but should be approached with caution.
Legislation pending in the U.S. state of Kansas to stop the use of environmental, social or governance (ESG) considerations by public contractors would reduce state pension system returns by $3.6 billion over 10 years, a new fiscal analysis shows.
With expected returns cut by 0.85%, "the KPERS general investment consultant projects that the investment portfolio returns would reduce by $3.6 billion over the next ten years when compared to the current investment portfolio," the note states.
At a public hearing on Wednesday about the bill and related legislation, KPERS Executive Director Alan Conroy said his agency would be forced to drop fund managers even if they were not running state assets with an ESG mandate, such as if their CEO had shared views about ESG investments.
Companies committed to ESG favor protection of natural resources, human rights, health and safety, community engagement, transparency, compliance with regulatory policies, diversity, equity and inclusion. Investors like the potential.
These southern states... now prohibit the biggest Wall Street banks from arranging and selling their new bond offerings because they’re “woke,” often assigning the job smaller firms that may not have the resources or reach to ensure that the borrowers are getting the lowest possible borrowing costs.
Since it began its assault on ESG in 2022, Texas, with its perfect AAA credit rating, is paying 19 basis points more in yield (the equivalent of $1.9 million on every $1 billion of bonds sold) than AA rated California on routine borrowings
Florida now pays 43 basis points more in yield (or $4.3 million for every $1 billion of bonds sold) than California with an inferior credit rating, or 0.35% more than it did prior to 2022. The Florida deterioration is a record, according to data compiled by Bloomberg.
Texas issuers will incur $300-$500 million in additional interest on the $31.8 billion borrowed during the first eight months following enactment.
Support for ESG
A new study released by IBM... found that more than 70% of executives view ESG as a revenue enabler, and that consumers increasingly focus on companies’ sustainability performance when making purchasing and employment decisions.
The executive survey indicated that ESG is a top priority for businesses, with 76% of respondents reporting that it is central to their business strategy, 72% approaching ESG as a revenue enabler rather than as a cost center, and 45% expecting ESG efforts to result in improved profitability.
The study also found a strong sustainability focus among consumers, with around two-thirds of respondents reporting that environmental sustainability and social responsibility (68% and 65%, respectively) are very or extremely important to them, with these priorities already impacting employment and consumption decisions. More than 70% said that they would be more willing to apply for a job with a company that they consider environmentally sustainable or socially responsible, with over 40% willing to accept a lower salary to work for such a company – and a quarter of those who changed jobs in the past year reporting that they did so.
State pension funds or other powerful players in at least five Republican-controlled states say that instead of creating excellence, these new culture-war policies are interfering with the market and could cost pensioners and taxpayers billions of dollars.
The anti-ESG efforts by Republican state politicians are backfiring in other ways, even turning some local bankers and regulators against the party.
If Kentucky, Louisiana, Florida, Missouri, West Virginia, and Oklahoma follow the Texas model, altogether their municipal bond underwriting costs could jump between $264 million and $708 million per year
All focus group participants agreed that America’s largest companies have outsize influence – both positive and negative – on society... they also believe that companies should be “good corporate citizens.”
Participants overwhelmingly chose the... stakeholder-focused model as the preferred option.
When polled for awareness, only a few participants said they had heard of the term “ESG.” We then asked whether they thought considering non-financial metrics made sense from an investment perspective. Many on both sides of the aisle find it part-and-parcel of a sound investment strategy.
85% of Americans agree that companies need to disclose more about their business practices and impact on society.
90% of Americans say it is important that there is a common, standardized reporting structure for companies and an average of 87% support the federal government requiring corporate disclosure on human capital and environmental impact data, making performance comparable across companies and/or industries.
90 percent of public pension funds — including 98 percent of funds in blue states and 80 percent of pensions in red states — showed support for key ESG resolutions in 2021.
Most notably, the Teachers Retirement System of Georgia voted against 99 percent of the ESG resolutions it was eligible to vote in and Ohio’s Public Pension voted against 67 percent of ESG resolutions.
The Teacher Retirement System of Texas and the Employees Retirement System of Texas voted in support of ESG resolutions 97 percent and 85 percent of the time, respectively.
ESG investments are projected to more than double in the next three years, accounting for 15% of all investments by 2025.
56% of financial professionals say traditional ways of valuing companies are inadequate for assessing sustainable investments, believing that the quality of ESG data available today is not yet sufficient to make investment decisions (52%)
Two-thirds (66%) of financial leaders say ESG investing is the number one driver for sustained, long-term growth
Asset managers globally are expected to increase their ESG-related assets under management (AuM) to US$33.9tn by 2026, from US$18.4tn in 2021.
With a projected compound annual growth rate (CAGR) of 12.9%, ESG assets are on pace to constitute 21.5% of total global AuM in less than 5 years.
A survey of 550 Bloomberg Terminal users found that more than 60% expect ESG to be a standard part of, or increasingly critical to, running a business.
By comparison, roughly a third of the respondents think the strategy that takes into account environmental, social and governance issues — and impacts roughly $40 trillion of assets — is just a “fad.”
The majority of people (76%) feel companies play a vital role in society and should be held accountable to make a positive impact on the communities in which they operate.
This finding is consistent across political lines as both the majority of Republicans (69%) and the majority of Democrats (82%) agreed.
The survey found that well over half (57%) of companies have already implemented a cross-functional working group tasked with driving strategic attention to ESG
Virtually all (99%) respondents said that they were somewhat or very likely to invest in more disclosure-focused technology and tools in the next 12 months
Financial Impacts of Climate Change
Deloitte’s Global Turning Point Report finds that unchecked climate change could cost the global economy US$178 trillion over the next 50 years, unless global leaders unite in a systemic net-zero transition.
The report analyzed 15 geographies in Asia Pacific, Europe, and the Americas, and found that if global leaders unite in a systemic net-zero transition, the global economy could see new five-decade gains of US$43 trillion—a boost to global GDP of 3.8% in 2070.
Transitioning to a decarbonized energy system by around 2050 is expected to save the world at least $12 trillion compared to continuing our current levels of fossil fuel use.
A transition to nearly 100% clean energy by 2050 results in lower energy system costs than a fossil fuel system, while providing more energy to the global economy, and expanding energy access to more people around the world.
Nearly three-quarters of respondents said that their organizations plan to increase budgets for the next 12 months in all four categories, and nearly all (97%) planning to increase the budget for at least one of the categories.
Business leaders are satisfied with the results of their recent sustainability efforts, with around 90% reporting that they were “Somewhat or Extremely Successful” with their prior 12-month goals across the four categories.