President-elect Joe Biden speaks from Biden’s interim headquarters in Wilmington, Delaware on December 14, 2020. (Mike Segar / Reuters)
ESG fans might experience a rude awakening as their rhetorical dream becomes an obligatory reality.
P.olitized Investments, particularly in environmental, social and governance (ESG) areas, have seen some regulatory setbacks over the past year, but the prospective Biden administration is widely expected to reverse and accelerate in the opposite direction in January. While many ESG proponents claim that their investment philosophy is a market-driven phenomenon, it is likely to receive the largest government-sponsored boost yet. It remains to be seen, however, whether fans of “enlightened” capitalism will ride this wave or be submerged by it.
That year, the Trump administration’s Department of Labor, which is responsible for pension funds covered by the Employee Retirement Income Security Act (ERISA) of 1974, published two key rules on politicized investing. The first rule reiterated ERISA’s longstanding expectation that plan managers need to make investment decisions for plan beneficiaries only in terms of financial return (with one limited exception) and not in terms of “socially responsible” considerations, even though plans allow beneficiaries Enable Self-Determination Directly, their retirement assets can include ESG-themed funds as an option if these goals can be achieved essentially without affecting financial returns. The second rule applied to pension fund managers voting on corporate shareholder resolutions on behalf of their beneficiaries, and it similarly affirmed that returns, not politics, should guide their decisions.
Unfortunately for American retirees, Team Biden is widely expected to ignore or actively undermine enforcement of these two rules. Since formal repeal of a published regulation can be time consuming and legally complex (as the Trump administration has found out more than once), it will be much easier to simply publish a new interpretation of the meaning of the rules. Morningstar’s Jon Hale predicted in November that “the Biden [Department of Labor] I’ll look for ways to clear that up, if not the other way around [ESG pension-fund] Rule. We expect sub-regulatory guidelines like FAQs and expert opinions to help bring things back to the old status quo. “
A lot can be done with “sub-regulatory guidance” or – as my colleague Wayne Crews likes to call it – “regulatory dark matter”. Suffice it to say that any system whereby a new rule marked “X” in relation to a rule can immediately be interpreted as “not X” by the next government does not instill much confidence in the rule of law or in the case law provide the regulatory security that investors allegedly crave.
The redefinition of ERISA pension rules, however, is possibly the least of a concern. Biden said he viewed climate change as “humanity’s main problem” and that climate has long been the most important of the many issues that come under the umbrella of the ESG. Former Secretary of State John Kerry will be the government’s “climate officer” and will have a seat on the National Security Council. Biden has also named former Environmental Protection Agency administrator Gina McCarthy a “Climate Bazar,” a position that will include “lead,” according to the NPR[ing] an office or policy council similar to the domestic policy council. “Senator Tom Udall (D., NM) told the New York Times last month that in the new administration, not only would traditional environmental regulators be working on the issue, but rather,” It will be a holistic approach to government. “
Biden also endorsed the Green New Deal, describing it as “a critical framework for addressing the climatic challenges we face”. However, his campaign was much calmer about what such a framework would cost Americans. A 2019 study by my colleague Kent Lassman from the Competitive Enterprise Institute and Daniel Turner from Power the Future shows that actually implementing the Green New Deal would cost $ 70,000 per US household in the first year alone. The cost in a state like Alaska, which is currently more dependent on fossil fuels, would be closer to $ 100,000 per household. This would be great for anyone selling solar panels to the government, but disastrous for the nation.
In the Biden campaign, particularly in the financial sector, it was called for “to oblige public companies to disclose climate risks and greenhouse gas emissions in their operations and supply chains”. But what counts as a climate risk? ESG proponents have argued for years that fossil fuel disclosure and divestment is simply a smart investment strategy, driven by market forces and with a desire to avoid holding stranded assets. The main reasons investors are turning away from oil and natural gas are politics, not market demand. Organizations like the United Nations-sponsored Principles for Responsible Investment have been trying for years to scare investors with the threatening-sounding “Inevitable Policy Response”. This is the claim that governments around the world will sooner or later make it toxic or legally impossible to invest in traditional energy sources, so anyone with the capital to better allocate can get on the climate activism train now. That is no more of a market phenomenon than the decision to sell your distillery investment as the nation’s 36th state is about to ratify the 18th Amendment.
From an industry perspective, the irony of this political pressure is that ESG investing is supposedly already a spectacular success. Virtually every media article that ponders the phenomenon claims that it is gaining momentum, being blown up, or “a sizzling sector”. However, this is mainly because fans were able to toss these three letters around with no definition or binding guidelines on what they actually mean. The expectations of an ESG investment are so loose that some of the movement’s true believers have chosen to denounce it. For example, Social Capital founder and CEO Chamath Palihapitiya made headlines around the world when he called the world of ESG investing a “total scam” in February.
However, federal policy makers under the Biden administration might be about to upset this comfortable world with no hard-to-define definitions. Fund managers and analysts excited to celebrate the burgeoning trillion dollars of supposedly ESG-focused investments might be upset and surprised when they suddenly become out of compliance. The simple virtue of “socially responsible” investments that don’t even require you to part with profitable oil stocks to be a leader in climate finance could finally come to an end. Years of keynote speeches and Davos workshops by industry leaders on the need to take climate change seriously come home to settle down. Let’s hope the ESG boosters don’t get whiplash if they argue against new rules that would actually do so.