Wednesday 11 January 2023
Something strange has begun to transpire with regard to Environmental, Social, and Governance (ESG) principles in the investment decision making process. In a most curious turn of events, some have found the consideration of financially material ESG information to be an infringement of fiduciary duty. Of late, the attorneys general of Arizona and Nebraska laid bare a litany of complaints and accusations against Blackrock, the world’s largest money management firm, for its position on ESG investing. Not only do these two states warrant consideration for these concerns in their own right, but their complaints were endorsed by the Attorneys General of 17 other Republican states, rendering the list of issues a veritable red wave of ESG backlash.
What’s behind the hostile response, largely from the political right, to integrating material ESG information into investment decision making? What is driving the sudden shareholder activism displayed by this letter to Blackrock?
The letter from 19 state Attorneys General indicates a deep distrust and disagreement with Blackrock’s investment thesis, which involves not only recognition of, but coordinated mitigation of climate change and the role of the investment community in doing so.
Notably, many of the state Republicans accusing Blackrock of “woke capitalism” are active members of a group called the State Financial Officers Foundation, on whose website is featured an emblem that states: “Educating Americans on the Dangers of ESG. Our money Our Values.” One wonders which values are threatened by a desire to protect the planet and build an equitable society while delivering healthy, market beating returns. As an aside, the SFOF website (including a podcast focused on American exceptionalism) is an interesting place to spend some time, if one is interested in understanding where this movement is gaining its momentum.
At issue is Blackrock’s recognition that climate change exists and that it has a role to play, as the world’s largest asset management firm, in influencing the emissions behavior of portfolio companies in which it invests. The letter from this cohort of Attorney’s General suggests that Blackrock’s sole responsibility is to seek out and achieve the best possible market rate returns.
The specific areas of contention, outlined in the letter are:
- Neutrality: While Blackrock has claimed agnosticism on the topic of energy and corresponding investment options, the letter posits that Blackrock’s membership with the Net Zero Managers Alliance (NZMA) undermines that position of neutrality.
- Dialogue (vs. Activism) The letter claims that rather than engaging in dialogue, Blackrock has shifted toward a more activist role on the issue of Climate Change
- Duty of Loyalty (i.e. Fiduciary Duty) and what it means to these states. The letter charges that Blackrock has displayed “mixed motives” and has violated its duty to focus solely on the financial returns of investments.
- Duty of Care, in which the letter suggests that energy security is not in alignment with decarbonization; and where the two are in conflict, energy security should win.
- Antitrust: as a result of coordination and market dominance held by Blackrock and peers, the letter suggests that these entities are acting in a way that raises antitrust concerns.
- Energy Boycotts, in which the letter suggests that by penalizing companies for failing to meet emissions standards beyond that which is required by law, is effectively a boycott and out of alignment with both fiduciary and legal duty.
“A fiduciary responsibility requires putting your client’s best interests ahead of any political agendas,” said Arizona Attorney General Mark Brnovich. “Helping to ensure financially secure retirements must be the first priority of this asset manager.”
A glaring absence from the list of complaints is concern over performance. Despite making allowance for ESG considerations and contributing to climate change mitigation, Blackrock is not underperforming. And isn’t that what these concerns are supposed to be about? If the stated concern is over fiduciary duty and placing financial returns above ESG considerations, then the most important trigger for action would be a reduction in returns or a lag in financial performance. But this is not the case. And it’s not really the issue.
ESG management and public disclosure is shown to improve company performance. This should ostensibly be in the best interests of all: Limited Partners, General Partners, Portfolio Companies, and the citizens whose money is being managed.
Last December, in a similar move, Governor Ron DeSantis announced that the State of Florida would be divesting $2 billion from Blackrock, due to its “woke” investment practices. The Florida State Chief Financial Officer, Jimmy Patronis (a SFOF member), said he did not support Blackrock’s “social engineering.”
“As a fiduciary, everything we do is with the sole goal of driving returns for our clients.” They added, “We are surprised by the Florida CFO’s decision given the strong returns BlackRock has delivered to Florida taxpayers over the last five years. Neither the CFO nor his staff have raised any performance concerns.”
The way in which ESG is being politized is neither surprising nor new. But it’s certainly, as with many things, ‘bigger in America’. There’s been minor backlash to ESG in Europe, but nothing at the scale of what we are observing in the US. A recent PitchBook Survey on Responsible Investing revealed that “..73% of European asset managers use an ESG risk factor framework and 70% offer impact investing strategies, compared to 56% and 61%, respectively, for North Americans.” And there seems to have been a pronounced drop in ESG alignment from 2021 to 2022. “The percentage of respondents who said they have no plans to incorporate sustainable investment practices nearly doubled over 2021’s results, with North American LPs being the primary driver of this increase.”
In many ways, ESG is being used as a scapegoat for critics – and a red herring for everyone – to enable the political left and right to have a platform to denounce one another, and to gain vindication amongst their bases. Notably, both sides cite a focus on returns and the rights of average Americans whose pensions will be affected.
Something that rings true about Blackrock’s public response to divestment and to criticism over climate change action has to do with inclusion – even of companies that are in a transitionary period. Investors have the unique opportunity to support their portfolio companies to improve, to begin ESG disclosures and reporting, to make progress toward energy transition, and to do so in a way that prioritizes progress over perfection. It’s better to engage companies on this journey and to financially support them, rather than to exclude and to leave their existing infrastructure and institutional knowledge out in the cold.
Critics of ESG claim that investors’ returns should take priority over ESG considerations. ESG advocates maintain that management and disclosure of financially material ESG information serves to improve company performance, bolster reputations, and ultimately ensure better and more sustainable returns.
This issue is not meant to be political. It’s meant to be financial. And perhaps aspirational. We all want our investments to outperform the market. We all want our values reflected in our wealth creation. We all want to live in a world where it’s safe to breathe the air, drink the water, and swim in the sea. When our children grow up and move into the workplace, we want it to be a fair, just, equitable place for them – one in which their efforts will be rewarded and they will be nether favored nor faulted by their skin color, country of origin, sexual orientation, gender or abilities/ disabilities. These principles do not land a person on the political left or right. But these principles, often embodied by the disclosure requirements of ESG, are being scapegoated to advance a particular set of interests in the US. We can do better than this. And we can create a financial ecosystem in which both ESG and top financial returns are enjoyed. And it’s arguably the only kind of world most of us are keen on inhabiting.