FILE – Visitors to the Financial District walk past the New York Stock Exchange, Friday, Sept. 23, 2022, in New York. After sweeping battles in statehouses across the country, the war against so-called environmental, social, and governance investing is heating up in Congress. (AP Photo/Mary Altafer, File)
The latest culture war issue on which everyone is expected to have a say is environmental, social and governance issues. This three-letter acronym, which stands for “Environmental, Social and Governance,” is a set of principles created to help guide investment decisions for companies that want (or are required) to be “socially responsible.” Companies are ranked on everything from their environmental profile, to business conditions, to diversity on their boards. Many companies and financial institutions have pledged to adhere to ESG principles or invest only in companies that do.
To some extent, ESG is just the latest form of the ancient practice of values-based investing. People have long wanted to ensure that their investments yield social benefit as well as personal gain, and individuals who wish to do so can put their money into funds that will not invest in certain industries such as arms manufacturers or pornography.
What makes ESG different is the scale of the matter. In 2021, the market value of ESG-related assets under management reached $18.4 trillion. For ESG advocates, it is simply a reasonable way to reconcile capitalism with environmental and social concerns. Critics see this as merely the latest “woke” fad, or even, more seriously, an attempt to impose a social credit system on an unaware population.
The fact that people have such conflicting and passionate opinions on ESG issues is not necessarily a problem. We all have to fill the hours of the day in one way or another. The biggest problem comes when countries start trying to impose ESG standards or prevent private companies from acting in accordance with them.
California has been leading the blue-state push to impose environmental, social, and governance (ESG) standards on companies. Last year, the state passed a pair of laws requiring companies operating in California to report their greenhouse gas emissions, as well as mitigation efforts and other climate-related financial risks. Notably, emissions reporting requirements include “upstream and downstream indirect greenhouse gas emissions…from sources that the reporting entity does not directly own or control.” Knowing how to calculate this will be a costly challenge for companies, and failure to disclose properly could ultimately expose companies to fines or securities fraud charges.
On the other hand, many red states have enacted laws that attempt to thwart ESG issues. In 2021, Texas passed a law that makes private companies ineligible for government contracts if they restrict investment in the fossil fuel industry. The law has led to some strange situations.
Recently, Texas Lieutenant Governor Dan Patrick held an event with BlackRock CEO Larry Fink as part of an effort to encourage companies to invest more in Texas' electric grid. However, BlackRock itself is on a list of sanctioned companies that cannot do business with the country due to its environmental, social and governance obligations. Texas thus finds itself in the awkward position of encouraging more capital investment in the state, while at the same time making it difficult for the same companies to do so.
To date, 22 states have passed pro- or anti-ESG legislation, resulting in a fractured financial services landscape. All of these conflicting mandates and prohibitions can push companies in different directions. If it continues, it may soon be impossible for an individual company to comply with all state regulations.
It is time for countries to take a step back. Even if state legislatures were full of Nobel Prize winners, it would be arrogant for them to assume that they know how to invest people's money better than they know themselves.
Blue states like California need to realize that companies have been working to reduce their environmental impact, even in the absence of government mandates. Considering environmental risks and the associated impact on community relations and the company's brand is something a company must do even if all it cares about is the bottom line. Harsh attempts by states to push the process could cause headaches for companies and risk a backlash from more conservative parts of the country.
Red states shouldn't question companies' investment decisions, either. If an investor believes renewable energy is the way of the future and does not want to invest in fossil fuel companies, they should be able to put their money where their mouth is. If they turn out to be wrong, the free market will do a better job of punishing them than any state bureaucrat.
In a world where Taylor Swift is a political issue, the controversies behind ESG are unlikely to be resolved any time soon. But if countries continue to pursue contradictory policies on the issue, they risk turning America into a giant mess of regulatory Swiss cheese.
Josiah Neely is a senior resident fellow in the Energy and Environment team at the R Street Institute
