With the 2022 midterm elections practically within the rearview mirror, has the momentum in direction of ESG shifted, or is the backlash that was rising round ESG nonetheless gaining floor? The meteoric rise of ESG over the previous a number of years was predicted to obtain pushback by the hands of a Republican Congress. Now that’s much less sure.
Nearly all massive buyers have embraced ESG as a way to guard and improve long-term shareholder worth. However the honeymoon seems to be over. With the U.S. midterm elections and growing fears of a world financial slowdown, sure members of the Republican celebration launched a strong marketing campaign earlier this yr linking ESG with every part from cultural “wokeism” to excessive fuel costs to nationwide safety issues. Whereas the deserves of those arguments may be debated, one factor appears clear – firms face the very thorny process of speaking their ESG initiatives to each pro- and anti-ESG buyers and regulators.
State and Federal ESG Initiatives
As Congress shifts fingers at the beginning of the brand new yr, Republican management of the Home will put the Congressional agenda at odds with the goals of the Biden administration, particularly on ESG regulation. Which means there’ll seemingly be little room for settlement on federal ESG-related laws within the 118th Congress, and rhetorical debate will dominate the Congressional panorama. Nonetheless, within the vacuum created by lack of legislative progress, search for states and federal companies to step into an outsized policymaking function on ESG (see Appendix).
Company Rulemaking
We anticipate the Biden administration to proceed its deal with enhancing ESG disclosures by means of rulemaking and oversight at federal companies, most notably the Securities and Alternate Fee (SEC). The SEC has taken a big curiosity in ESG, establishing a brand new Local weather and ESG Process Drive throughout the SEC’s Division of Enforcement, whose mission is “to develop initiatives to proactively determine ESG-related misconduct.” It has additionally promulgated new ESG guidelines on each firm local weather disclosures and ESG funds whereas signaling extra ESG disclosure necessities to return. And, after all, the U.S. political setting has little bearing on the evolving ESG disclosure laws in Europe.
Congressional Motion
Whereas federal laws just isn’t prone to be handed on this new Congress, anticipate the controversy over ESG to proceed. Because the SEC’s ESG initiatives have already sparked vital criticism from Republicans in Congress, we anticipate that this development will solely proceed beneath new Republican management. Whereas a Republican-led Home can not block SEC guidelines, it may possibly search to gradual its rulemaking by means of inquiries and investigations – which can embody compelling firms who’ve invested strongly in ESG initiatives to testify earlier than Congressional committees. We have now already seen hints of this as, simply days earlier than the midterm elections, a bunch of Republican Senators despatched letters to 51 massive company regulation corporations warning them that they are going to be taking motion “to scrutinize the institutionalized antitrust violations being dedicated within the identify of ESG” by the corporations’ company purchasers.
Second, anticipate present ESG laws to be reintroduced as the 2 events search to advertise their messaging on ESG – even when the laws doesn’t have a powerful likelihood of passage. Democrats will proceed to push for laws such because the Company Governance Enchancment and Investor Safety Act, which handed the Home in 2021 and would require enhanced disclosures for publicly traded firms on a wide range of ESG-related matters. On the Republican facet, laws such because the Investor Democracy is Anticipated (INDEX) Act (which might limit the voting energy of huge asset managers like BlackRock) and the No ESG at TSP Act (which might prohibit investments beneath the Thrift Financial savings Plan in mutual funds that make funding choices based mostly totally on environmental, social or governance standards) will seemingly be given additional consideration beneath a Republican majority.
State-Degree Initiatives
Lastly, states will proceed to have interaction on ESG coverage, and in some instances increase on current initiatives, primarily specializing in ESG disclosure necessities for state pension funds. In latest periods, Texas, Oklahoma, Kentucky and West Virginia have handed laws that may prohibit or considerably limit investments in (and enterprise with) monetary establishments that boycott power firms. Different states comparable to Florida have enacted guidelines to ban ESG issues in pension fund investments. Nonetheless, because the pro-ESG motion responds and beneficial properties political capital, anticipate Democratic-run states to not solely improve ESG disclosure necessities but additionally search to divest from sure sectors. We will look to just lately launched laws for signposts about what this may occasionally seem like. For instance, California, Massachusetts and New Jersey are at the moment contemplating laws that may prohibit funding in fossil gas or firearm manufacturing firms and require funding in firms which are aligned with the objectives of the Paris Local weather Settlement. On the similar time, Republican-run states are primarily seeking to restrict the proliferation of ESG funding practices of their state pension funds. Anticipate each pro- and anti-ESG state regulatory tendencies to proceed in 2023.
Investor Response to the Anti-ESG Sentiment
The “Massive 3” React
Regardless of the anti-ESG sentiment from sure regulators, massive institutional buyers have proven no indication that they’re de-prioritizing ESG points. BlackRock’s 2022 Annual Voting Highlight printed in September famous that “it’s crucial that we search to grasp and assess how [ESG] dangers and alternatives will impression the businesses through which we make investments…” State Road World Advisors (SSGA) reiterated its deal with “addressing all financially materials points – together with ESG points – by means of our proxy voting and firm engagement…” in its latest insights piece. Pension funds such because the NYC Comptroller have despatched letters to their asset managers asking them to extend the strain on firms to make progress on essential ESG points comparable to local weather and variety.
Proxy Season Information and Market Developments
Whereas the 2022 proxy season outcomes indicated a slight lower in shareholder assist for “E” and “S” shareholder proposals total, they nonetheless far exceeded assist ranges from simply two years in the past – particularly these associated to local weather, range and political contributions. As well as, proposals asking firms to not deal with ESG points routinely acquired negligible assist from shareholders. Waiting for the 2023 proxy season, outcomes from the latest Institutional Shareholder Companies annual survey indicated {that a} majority of buyers are looking for extra local weather threat disclosure from firms – not much less. New “common poll” necessities for proxy contests, new government compensation disclosure necessities and initiatives that give asset supervisor purchasers the flexibility to vote themselves (e.g.; BlackRock’s Voting Alternative) will add to the growing uncertainty of vote outcomes on ESG points transferring ahead.
The Looming Recession
Corporations are additionally dealing with robust choices on ESG – not solely from anti-ESG sentiment from some regulators, but additionally from the looming recession. How are firms reacting thus far? The Environmental Sustainability Index printed by Honeywell in October indicated that “practically 9 out of ten organizations are planning to extend sustainability budgets for the approaching twelve months.” A latest Nasdaq examine indicated that of 2nd quarter earnings calls this yr for Russell 300 firms, 78% mentioned ESG matters, and 20% had been requested ESG-related questions from sell-side analysts. Nonetheless, some firms might face troublesome choices in the case of ESG.
Trying Forward
With a lot uncertainty dealing with each the market and the regulatory setting, what method ought to firms and boards tackle ESG? As we noticed with the financial challenges of the pandemic, massive buyers are prone to stay firmly dedicated to their perception that some ESG points can have a cloth impression on an organization’s long-term monetary efficiency. Along with specializing in good monetary efficiency, firms and boards ought to proceed to deal with the ESG points which are most materials to the enterprise. As a substitute of talking about ESG within the summary, it could be helpful to be extra particular in deliberations. For instance, is local weather change nonetheless a threat to the enterprise? Is range nonetheless essential to the corporate’s stakeholders? Is an impartial and various board nonetheless essential? The reply to those and different questions is probably going nonetheless “sure,” no matter how politicized the time period ESG turns into. Clearly speaking an organization’s deal with materials ESG points to stakeholders – which can now embody “hidden” asset supervisor purchasers in addition to regulators who’re against ESG – has by no means been extra essential.
Appendix
States which have launched pro-ESG investing laws
1. California
2. Hawaii
3. Indiana
4. Maryland
5. Massachusetts
6. New Jersey
7. Vermont
8. Virginia
States which have launched anti-ESG investing laws
1. Florida
2. Idaho
3. Indiana
4. Kentucky
5. Louisiana
6. Minnesota
7. Missouri
8. Oklahoma
9. Texas
10. Utah
11. West Virginia
The views and opinions in these articles are solely of the authors and don’t essentially replicate these of Teneo. They’re supplied to stimulate thought and dialogue and never as authorized, monetary, accounting, tax or different skilled recommendation or counsel.
