ESG never had it so good! For starters, notice how I didn’t feel like I had to spell out the acronym. Until recently that was hardly the case. Gloriously, what the letters stand for is now known across the political spectrum. Not surprisingly, the meaning of the acronym varies across the political spectrum as well. This illustrates how ideology infuses language. Fiduciary duty is another example, particularly in the context of ESG. This is a story for another day.
Professor Elizabeth Pollman has written about the origins of the acronym. It can be traced back to the formation of the UN Global Compact and a 2004 report titled “Who Cares Wins: Connecting Financial Markets to a Changing World.” At that time George W. Bush was President and head of a very different Republican Party than the one we have today. Although my own political leanings are to the left, I yearn for the days of principled conservative views. But that too is a story for another day.
Reading Professor Pollman’s excellent paper inspired me to re-read the report. It was a very interesting and informative exercise in light of the almost insane politicization that has happened in the U.S. to ESG which I have written about and discussed in a podcast with Amy Cortese of ImpactAlpha.
New York Stock Exchange, Wall street, Manhattan, New York, USA
“This report is the result of a joint effort of financial institutions which were invited by United Nations Secretary-General Kofi Annan to develop guidelines and recommendations on how to better integrate environmental, social and governance issues in asset management, securities brokerage services and associated research functions. The work that led to this report took place under the auspices of the U.N. Global Compact.”
Twenty financial institutions (including Calvert, Goldman Sachs, and Morgan Stanley) from nine countries with $6 trillion in assets under management participated in and put their names on the report stating, “Endorsing institutions are convinced that a better consideration of environmental, social and governance factors will ultimately contribute to stronger and more resilient investment markets (emphasis mine), as well as contribute to the sustainable development of societies.”
To make clear the capital market focus of the report, it notes that “we have refrained from using terms such as sustainability, corporate citizenship, etc., in order to avoid misunderstandings deriving from different interpretations of these terms.” Oh, and just to note, that not a single nefarious progressive NGO was a signatory to this report. Oh and to also note, the much-maligned BlackRock wasn’t a signatory either.
The report was visionary in a number of ways, including a “Goldman Sachs Energy and Social Index” which scored oil and gas companies across eight environmental and social indicators (Figure 3) and a graph of the potential range of impact of climate change policies on automobile companies (Figure 4). So the question here is whether these financial institutions were already sneakily beginning a seditious progressive left-wing Woke campaign to undermine the companies they were invested in (kind of counterintuitive, right?) or whether they were seeing ESG as a way to ensure long-term value creation (which makes a lot more sense to me).
Okay, let’s flash forward 18 years. How have the markets done? ? The S&P 500 Index was at 1,121 in January of 2004. It peaked at 4.725 in December 2021. It’s now down to 3,770, still higher than its peak during the Trump administration of 3,234 on January 3, 2020. Just before he left office. Rather unwillingly. And today’s index is taking account of Russia’s invasion of Ukraine which has led to high oil and gas prices, contributing to the highest rate of inflation in 10 years. Doesn’t look to me like ESG has damaged the markets and shareholder value creation.
Kids zone vector cartoon label. Colorful lettering for children’s playroom decoration
But why let facts get in the way of having some political fun and games? Little lonely ESG has now made the Big Time and is being used to wind up the Republican base, almost sitting alongside guns and abortion. On these two, I recognize that there are strongly opposing political views but at least both sides are talking about the same thing.
That ain’t the case with ESG. Those Republicans who are critical of ESG, and I suspect they are the minority although I don’t have any data to prove this, have had the clever inspiration to give it their own definition! It’s like me defining “U.S. energy security,” which I support, as “preventing blue states from buying energy from red states” and then railing against a nefarious red state political agenda to damage their fellow citizens. Of course I would be opposed to this. It is positively un-American!
I have previously discussed the erudite Republican Study Committee memo “The War on American Energy Ground Zero” which defines ESG as “ the progressive scheme through which the Left pressures corporate America to take positions on social and political issues that have nothing to do with business.” Here they are loyally parroting former Vice President Mike Pence who wrote in an op-ed piece to the always GOP-enabling Wall Street Journal stating that “ESG is a pernicious strategy, because it allows the left to accomplish what it could never hope to achieve at the ballot box or through competition in the free market. ESG empowers an unelected cabal of bureaucrats, regulators and activist investors to rate companies based on their adherence to left-wing values.”
In a sincere effort to help explain ESG investing to Mr Pence and his friends I pointed out that ESG is about managing material risks to value creation. As described in “Who Cares Wins.” For example, using guidance from the Sustainable Accounting Standards Board (of which I was the founding Chair), the material risk factors for an oil and gas exploration company are shown in the figure below. I’m sure the growing list of ESG haters would grant me that employee health and safety, business ethics, management of the legal & regulatory environment, critical incident risk management, business model resilience, and human rights and community relations are important risk factors.
That leaves the buggy boo of environmental issues: GHG emissions, air quality, water & wastewater management, and ecological impacts. There are laws about all of these issues. But let’s pretend there weren’t. Are they saying that an oil and gas company truly dedicated to shareholder value creation can and should ignore these topics with impunity?
SASB Standards- Oil & Gas – Exploration & Production
Florida governor Ron DiSantis, another aspiring GOP Presidential nominee, has also jumped on the anti-ESG bandwagon to burnish his conservative credentials. Since he’s a governor he can actually pass some legislation which he did on August 23, 2020. Along with his fellow Trustees of the State Board of Administration (SBA) he passed a staunch resolution that state funds should be invested “without considering the ideological agenda of the environmental, social, and corporate governance (ESG) movement” based on “social, political, or ideological interests.”
This does put the Florida pension funds in an awkward position. If they listen to the Guvnor, they will ignore material risk factors and hurt the funds’ returns to the detriment of their beneficiaries. If they don’t, who knows what will happen? I mean, he might put them on a plane to Martha’s Vineyard!
WASHINGTON, DC – DECEMBER 10: Rep. Senator Pat Toomey (R-PA) questions Treasury Secretary Steven … [+]
The Republican ESG fun and games continue! On September 20, 2022, Retiring Senator Pat Toomey (R-PA), a graduate of Harvard College and the Ranking Member on the Senate Committee on Banking, Housing, and Urban Affairs sent a letter to 12 ESG rating agencies: MSCI, ISS, Bloomberg, Sustainalytics, Moody’s, Carbon Disclosure Project, S&P Global, FTSE Russell, RepRisk, FactSet, Refinitiv, and Arabesque S-Ray. Fun fact. Mr. Georg Kell is the Chairman of Arabesque Partners and was the founding Executive Director of the UN Global Compact.
I’m sure Mr. Pence is very pleased with this investigation since in his letter discussed above, he likens the ESG scores rating agencies give to companies as no different from “the social credit scores issued by the Chinese Communist Party.”
Question 11 asks, “Does a company’s involvement in a legal yet politically disfavored industry (e.g., fossil fuels, firearms, tobacco) negatively impact its ESG rating? If so, please list the industries.” Ummm. The answer is “No.” Mr. Toomey would have known this if he read the RSC memo letter since it expressed the exasperation (note the irony) that Tesla received a lower ESG rating than ExxonMobil. If it would be helpful to Mr. Toomey, he can read my explanation for this.
Question 12 is, “How do you determine which industries warrant a negative ratings impact and which ones do not?” Just FYI Mr. Toomey, the ratings are of companies not industries. It also might make him feel better to know that not just oil and gas companies, but tobacco companies (much to the consternations of this industry and ESG critics) can also get high ESG ratings.
Question 13 asks, “In assigning ESG ratings, how do you take into consideration, if at all, donations to organizations that promote political causes such as voting rights, police reform, racial justice, climate change activism, and abortion rights? If such donations are considered, how do they impact a company’s ESG rating? Please list any companies whose ratings have been positively impacted by the consideration of such donations.”
Fair enough to ask the question of whether political donations are a factor in these ratings although the list screams out Mr. Toomey’s political views. Of course, none of these are factors in ESG ratings. But how about asking if these rating agencies about right wing political causes? I’m just guessing that if they did, and you got ESG Brownie Points for being against voting rights, police reform, racial justice, dealing with climate change, and abortion rights, Mr. Toomey would be just fine with that.
Eleanor Terret of FoxBusiness couldn’t be more excited by what Mr. Toomey is doing. As she writes in her piece “Toomey Leads Charge Against ESG ratings firms,” Mr. Toomey is “providing a blueprint for how a potential GOP majority can defang the effort to push controversial “ESG” mandates on corporate America.” He is planning on turning over his findings to his GOP colleagues who “are promising to mount investigations into the ESG movement armed with subpoena power if Congress runs red after next week’s midterms, people close to the matter say.”
Adhering to the party line, she helpfully explains that “ESG is a broad term to describe an investing technique that has become both popular and controversial in recent years as some investors demanded corporate policies that took into account societal needs, not just maximizing shareholder value. It seeks to force public companies to take steps to protect the environment, create governance mandates that ensure diversity and adhere to principles that better society.” God forbid that companies adhere to any principles that would make for a better society! The same old blah, blah, blah that ESG hurts shareholder value creation while at the same time the left wing critics of ESG complain that it’s only about shareholder value creation and not making the world a better place.
Ms. Terrett notes how dire the consequences of this could be: “Companies, bullied by progressive activists, regulators in the White House, and egged on by ESG rating firms seeking a profit from the burgeoning business, cave to ESG demands.“ Well, this is indeed worrisome. Especially given the fact (not that facts matter to ideologues) that, as Professors Vyacheslav Fos of Boston College, Elisabeth Kempf of Harvard Business School, and Margarita Tsoutsoura of Washington University in St. Louis have pointed out in “The Political Polarization in Corporate America,” 69 percent of the highest paid executives in the companies covered by the S&P 1500 index are Republicans and 31 percent are Democrats.
I can only think of two hypotheses to reconcile her claims with these facts. The first is that all the Republican execs see ESG as being value enhancing. The second is that they are a bunch of wimps who are caving into a pernicious progressive movement and need to “Man Up.” (Lest I be accused of gender bias by either side, the paper notes that across all parties the percentage of women is 10.4.) If this is the case, I’d like to helpfully suggest to Senator Grassley that he send all of these spineless Republican execs an equally stern and admonishing letter telling them they’d better change the errors of their ways—OR ELSE!
WASHINGTON, DC – APRIL 20: U.S. Sen. Tom Cotton (R-AR) attends a Senate Judiciary Committee hearing … [+]
Not wanting to be left out of the glorious ESG limelight, five other Senators {Marsha Blackburn (R-TN), Tom Cotton (R-AR), Chuck Grassley (R-IA), Mike Lee (R-UT), and Marco Rubio (R-FL) have sent a letter to 51 law firms. The list contains many well-known law firms, but some inclusions and exclusions perplex me. An example of the former is White & Case which ranks as the most Republican law firm along with Proskauer Rose right behind them. (Well, I guess I have to give the Senators credit for not just picking on Democratic-leaning law firms. But I can’t help but wonder how the Republican-leaning ones reacted to getting the letter and what they are going to do about it.) An example of the latter is Wachtell Lipton Rosen and Katz, famous for Martin Lipton’s support of stakeholder capitalism and for its excellent series of “ESG Memos.” More on this below.
No doubt thanks to Senator Cotton’s education at Harvard Law School, the letter begins with a forceful first paragraph:
“We are writing about your firm’s Environmental, Social, and Governance (ESG) practice. Although businesses would certainly be wise to lawyer up before undertaking ESG initiatives, your firm has a duty to fully inform clients of the risks they incur by participating in climate cartels and other ill-advised ESG schemes.” Wow, climate cartels! Clearly Senator Cotton took some courses in antitrust law to learn this term.
In the “here we go again” nonsensical formulation of Mr. Pence, the RSC, and Mr. DiSantis, the letter asserts that ““The ESG movement attempts to weaponize corporations to reshape society in ways that Americans would never endorse at the ballot box. Of particular concern is the collusive effort to restrict the supply of coal, oil, and gas, which is driving up energy costs across the globe and empowering America’s adversaries abroad.” I’ve already shown this is a ludicrous contention. ExxonMobil’s market cap is at an all-time high of $462.49 billion and it projects generating $100 billion in fresh cash flow over the next five years.
And just to show they aren’t kidding and are willing to take the gloves off, the letter ominously closes with:
“To the extent that your firm continues to advise clients regarding participation in ESG initiatives, both you and those clients should take care to preserve relevant documents in anticipation of those investigations.”
Given attorney/client privilege, Harvard Law School certainly has some culpability here. Either the notion of attorney/client privilege isn’t in its curriculum, or they don’t properly assess whether their students understand the concept before giving them their much cherished Crimson law diploma to hang on their wall.
Getting back to poor ignored Wachtell Lipton Rosen and Katz, their September 22, 2022 memo “ESG, Stakeholder Governance, and the Duty of the Corporation states that “it is essential that boards operate under a governance model that permits consideration of ESG principles and sustainable investment strategies, with the support of investors and asset managers, to promote long-term corporate value and to fortify the enterprise against relevant risks. There should be no doubt that the law in Delaware and in every other U.S. jurisdiction empowers boards to follow this course for responsible corporate stewardship and corporate success.”
Let me conclude with some helpful advice to the five Senators. Better lawyer up.
