A bit of ESG introspection is no bad thing

Political potshots in the US are prompting investors to revisit the arguments for sustainability.

On Wednesday of next week, the House Financial Services Committee will convene to talk ESG. Specifically, the committee – which oversees the US’s financial regulators – will discuss “environmental and social policy in financial regulation”. This will be the latest chapter in the much-discussed ESG “backlash” saga and will address, among other things, whether the SEC under Gary Gensler has over-reached its remit with climate-related reporting rules and other potential ESG initiatives.

To some, the SEC is ensuring investors have access to decision-useful material data. To others, it is “weaponising the agency for progressive purposes“.

At times it’s hard to gauge how much of this wider “ESG backlash” rhetoric is feverish hot air, and how much is substantially relevant. As Andy Thomson noted in a long read about private debt and ESG this week, since the first “anti-ESG” piece of legislation was signed in September 2021 (a Texas bill to banish asset managers that boycott the fossil fuel industry), 13 other US states have adopted similar measures. Last year, Florida and Indiana moved to prohibit investors in their states from backing investments or strategies based on ESG: the interests of  fund beneficiaries would be the only consideration.

This seems like more than just hot air. But as we have noted before, legislation that demands investors make decisions based only on financial considerations should do nothing to change the way institutions invest. Florida State Board of Administration, for example, recently told us in plain terms that all its investment decisions are already “made singularly and solely for the purpose of maximizing financial return, managing risk, defraying reasonable costs and diversifying plan assets”. No change there then.

Furthermore, laws that ban some asset managers from working with state institutions are likely to be met with resistance from those tasked with protecting beneficiaries’ interests; such laws just reduce investors’ ability to select the best managers.

So what effect has the ESG backlash had so far? It has punctured any feeling of complacency that might have built up among ESG professionals about the growing importance of their role.

“Those in the industry for some time have seen their mandate rise and rise without much challenge,” said Michael Marshall, head of sustainable ownership at UK pension Railpen, at Responsible Investor‘s RI Europe conference in June. “It’s been in vogue. We’ve not really faced a backlash or a threat to our mandate […] I don’t think we are doing enough to counter it in a serious way.”

In particular, Marshall was worried about the “hearts and minds” effect of the backlash on frontline investment professionals. If their view of ESG is sufficiently tainted, then integrating responsible investment becomes very difficult.

Within private markets, the ESG backlash has prompted some of the largest firms to take a step back from the “how” and take another hard look at the “why”? In the recent crop of annual sustainability reports, Carlyle, KKR and Apollo all hammer home the connection between financial returns and sustainability considerations. They all make compelling cases.

If one outcome from the ESG backlash is a more robust and self-assured understanding of why ESG is a material financial consideration, then perhaps the political potshots serve a purpose.