The latest culture war issue about which everyone is expected to have an opinion is ESG. This three-letter acronym, which stands for Environmental, Social, Governance, is a set of principles created to help guide investment decisions for companies who want (or are required) to be “socially responsible.” Companies are graded based on everything from their environmental profile, to working conditions, to diversity on their boards. Many companies and financial institutions have pledged to abide by ESG principles or to only invest in companies that do.
To some extent, ESG is just the latest form of the old practice of values-based investing. People have long wanted to make sure that their investments yield a social benefit as well as producing personal profit, and individuals who want to can put their money in funds that won’t invest in certain industries such as arms manufacturers or pornography.
What makes ESG different is the scale of the thing. In 2021, the market value of ESG-related assets under management was $18.4 trillion. For advocates of ESG, it is simply a sensible way to reconcile capitalism with environmental and social concerns. For critics, it is just the latest “woke” fad, or even, more ominously, an attempt to impose a social credit system on an unwitting population.
The fact that people have such conflicting, passionately held views about ESG is not necessarily a problem. We all have to fill up the hours in the day somehow. The bigger problem comes when states start trying to either mandate ESG or prohibit private companies from acting according to it.
California has been leading the blue state charge to force ESG on businesses. Last year the state passed a pair of laws requiring companies operating in California to report their greenhouse gas emissions, as well as their mitigation efforts and other climate-related financial risks. Notably, the emissions reporting requirement includes “indirect upstream and downstream greenhouse gas emissions … from sources that the reporting entity does not own or directly control.” Figuring out how to calculate this will be a costly challenge for companies, and failure to properly disclose could eventually subject companies to fines or charges of securities fraud.
On the flip side, many red states have enacted laws trying to thwart ESG. In 2021 Texas passed a law making 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’ Lt. Gov. 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. Yet BlackRock is itself on the list of sanctioned companies that cannot do business with the state due to their ESG commitments. Texas thus finds itself in the awkward position of encouraging more capital investment in the state while simultaneously making it harder for the same companies to do so.
So far, 22 states have passed either pro- or anti-ESG legislation, leading to a fractured financial-services landscape. All of these conflicting mandates and prohibitions can pull companies in different directions. If it keeps up, it may soon be impossible for an individual company to comply with all of the state regulations.
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It’s time for states to take a step back. Even if state legislatures were full of Nobel Prize winners, it would be arrogant for them to assume they know better how to invest people’s money than they do themselves.
Blue states like California should recognize that companies have been working to reduce their environmental impact, even in the absence of government mandates. Accounting for environmental risks and their associated hit to community relations and the company’s brand is something a company should do even if all they care about is the bottom line. Heavy-handed attempts by states to push this process along can create headaches for companies and risks a backlash from more conservative parts of the country.
And red states shouldn’t be second-guessing companies’ investment decisions either. If an investor thinks that renewable energy is the way of the future and doesn’t want to invest in fossil fuel companies, they ought to be able to put their money where their mouth is. If it turns out they are wrong, the unhampered market will do a better job of punishing them than any state bureaucrat.
In a world where Taylor Swift is a political issue, it’s unlikely that the controversies underlying ESG will be resolved any time soon. But if states continue to pursue contradictory policies on the issue, they risk turning America into a giant mess of regulatory Swiss cheese.
Josiah Neeley is a resident senior fellow with the R Street Institute’s energy and environment team