It’s worth noting this flashpoint is being fanned by Republican states – many looking to secure finance for traditional fossil fuels to which ESG principles present obvious hurdles.
Notable players in the crusade include Florida governor Ron DeSantis and Vivek Ramaswamy.
De Santis has sought to ban the use of ESG criteria in all state investment decisions, and Ramaswamy, whose firm promotes exchange-traded funds (ETFs) and proxy-voting services that push back against what it sees as the politicisation of corporate governance, are both tipped to run in the Republican presidential primaries.
The integration of ESG to portfolio construction is so divisive that it may require Joe Biden’s first presidential veto. And with this noise growing louder, we could see significant implications for the asset management industry.
Why are the likes of De Santis seeking to strike this regulatory divide on ESG principles? Has a looming threat triggered the walls going up?
Political ideology aside, the core question here is whether implementing ESG principles poses any material financial risk to investments.
The answer – at least so far – is no.
In their recent analysis of the 50 US state pension funds, Rainmaker concluded that there was no difference between average investment returns over three to five years in Democratic states more likely to integrate ESG investment principles and Republican states more likely to ban them.
In fact, the only material difference in the short run was that Republican states underperformed.
But even more unhelpful for this stance was a study by Daniel Garrett of the University of Pennsylvania and Ivan Ivanov of the Federal Reserve Bank of Chicago. It found Texas’ anti-ESG laws had the unfortunate side effect of thinning out the number of bond underwriters, raising issuers’ interest costs by $300 million to $500 million in their first eight months.
Elsewhere in Indiana, an ESG ban was watered down after the state’s fiscal watchdog suggested that it would cut annual returns to the state’s public pension funds by 1.2 percentage points.
Talk about the price for taking a stand.
Some may argue it’s still too early to conclusively tell, but it’s certainly not the beginning of a great story.
As global fund managers, these are the waters we must navigate.
Across the Atlantic, for example, the European Union’s Sustainable Finance Disclosure Regulation legislation came into full force in January, requiring funds marketed or domiciled in Europe to sign up to an ESG transparency regime and commitment. There, managers can elect a “level” of commitment represented on a colour scale from blue to dark green. It comes as no surprise where the capital is flowing and going to flow – where the pastures are greener.
Raging political debate
Closer to home, asset managers are less torn by raging political debate on ESG at this moment.
Following the path paved by the EU, the Australian Sustainable Finance Institute have commenced a Technical Advisory Working Group to develop a clear sustainable finance taxonomy in Australia. Think of it as a guide for the transition of the economy, financial portfolios, companies, and economic activities by providing clear and consistent definitions of what is classified as a sustainable activity.
And given Australia’s commitment to net zero by 2050, it will also define how economic activities will need to transition over time to continue to be classified as sustainable.
While a relatively recent phenomenon, a Rainmaker study of ESG super performance showed that since 2019 – arguably when ESG impacts really came to the fore – ESG shows a performance edge for Australia’s leading super funds. While the sole purpose is the guiding light for superannuation funds, the Rainmaker view is that if a fund underperforms, it is not likely due to its ESG investment strategy.
Coupled with the fact ESG is now seen as a mainstream investment performance differentiator, the case against ESG does not appear to be one grounded on anything more than political ideology.
For all the talk of red states versus blue, one thing is certain; green investment will continue to grow, as it should. Financing the transition is critical, and regulatory certainty has an undeniable role to play.
The tides are changing. The waters of deglobalisation are unchartered, but we must keep swimming.
Katrina King is general manager, capital solutions, for QIC.
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